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Vehicle finance: The cost of balloon-payment contracts

They allow for lower monthly payments, but the ‘residual value’ – the portion of the capital amount of the loan that will be paid later – can hit where it hurts.
Longer car finance contracts plus a residual value results in a steeper depreciation curve. Picture: Moneyweb

As inflation continues to outpace salary increases, South Africans are increasingly opting for longer vehicle finance contracts and many are taking on a residual value of 30-35% as well.

A Broll retail report for the second quarter of last year showed that real salaries rose at an average of 4.9% per annum. However, when adjusted for inflation, salaries should have grown by 6.7% per annum for people to earn the equivalent, in terms of buying power, of what they earned in 2008.

Against this backdrop, Wesbank CEO Chris de Kock notes that 95% of car purchase agreements finalised by Wesbank are now 72-month contracts, spread over six years, and of those, 35% include a residual or balloon payment. 

Read: Second hand goes the distance 

“The value of the balloon payment or residual that falls due at the end of the six-year contract can vary, but it typically stretches out the repayments so that the consumer has a smaller monthly instalment,” he says.

For example, using the Wesbank affordability calculator, if you bought a car for R200 000 with a 10% deposit of R20 000 and a repayment term of 54 months, the monthly repayment at an interest rate of 12% would be R4 428.23. If, however, you financed the same car over 72 months with no deposit and a balloon payment or residual value of 30%, the monthly repayment at an interest rate of 12% would be R3 429.63.

Steeper depreciation

De Kock says previously, when consumers were taking out 54-month vehicle finance contracts with a 10% deposit, the point at which the outstanding finance amount intersected with the resale value of the car was usually around 36 months. However, with longer car finance contracts plus a residual value, there is a steeper depreciation curve and the point where the outstanding finance amount intersects with the resale value of the car is now typically around 48 months or when the car is four years old.

Ghana Msibi, Wesbank’s executive head for sales and marketing, warns buyers to be cautious of the amount put into a balloon because they will be responsible for the lump sum once the finance term is finished.

“While it may be attractive to have lower monthly repayments because a larger chunk of the purchase price is placed into a balloon, the repayment of a balloon can be an unexpected debt as this amount will either need to be settled or refinanced at the end of the deal,” he says.

Msibi adds that of the Wesbank consumers who take out contracts with a residual amount, only 5% opt to refinance the vehicle at the end of the initial hire purchase contract period. The other 95% either pay off the lump sum, trade in the car before the contract expires, or negotiate a repayment agreement such as paying off the residual amount over three months.

Henry Botha, head of strategy and business analytics at Absa Vehicle and Asset Finance, points out that the ‘residual value’ is just a deferred payment for a portion of the capital – 30%, for example – and allows for a lower monthly instalment. “The client is still responsible for repayment of 100% of the capital amount,” he says.

Prem Govender, managing partner at CP Naidoo & Partners, says consumers tend to forget that a car is a depreciating asset.

Impact on your asset

“At the end of a longer hire purchase contract, you are left with an asset that is not worth anywhere near what you paid for it and you still have to cough up a residual amount of 30 to 35% of the original price,” she says.

“Consumers who take out these contracts rarely have a lump sum saved up at the end of the period to cover the residual and, more often than not, resort to refinancing their older model vehicle, which is now out of warranty and service plan, with increased maintenance costs.”

Govender also points out that when you take out a longer repayment contract, you end up paying more interest in the long term.

For sound personal financial planning, Govender suggests that buyers rather consider a maximum repayment term of five years without a residual amount, and save first so that they have a lump sum deposit of 10% to 20% when buying the vehicle.

Another tip: “If you have equity in your home loan, you can use an access bond to pay cash for the car at the dealership. However, if you choose this option, make sure that you structure your repayments into the home loan such that you pay off the cost of the car within five years or less.

“The interest rate on a home loan is significantly less than that on a vehicle,” she says.



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anyone who buys a car with a balloon payment, that person doesn’t afford that car!! go argue with your salesperson!!

I always buy a car I can fully afford AND with the biggest balloon payment they will allow. I then immediately put the equivalent of the balloon payment into the share market and have always found that after 5 years I make a handsome return after selling the shares to settle the balloon payment.

Cant see you making profit on JSE shares in past 5 years equaling your interest rate of 12%+ ? on the car.

I bought my car in May 2012 with a 300k residual. I put 100k in Naspers; 100k in SAB; and 100k in Clicks. The interest rate charged by BMW was 8.5%. I sold out in May 2017. Not only did I make a handsome profit but I used it to fund a two week holiday in Europe and still had some money over.

Being such a great trader, why would you need to borrow money to buy a car?

I am not a trader, I am investor. I put that money away for 5 years, after all. This is just an obvious opportunity to help finance my car. And if the market went against me, with quality stocks I can’t lose in the longer run. The point is that with a little bit of common sense and discipline you can turn something that is meant to disadvantage you to your advantage. Balloon payments are not evil per se – it’s what you make of it that counts.

Exactly! Makes no sense

Read my comment properly. I did not invest in the JSE, I invested in Naspers, Clicks and SAB. There is no next bullet payment. It was all paid up in May 2017. I was lucky in that the market was significantly higher then than it is now. What is important is not the profit I made but the principle that balloon payments can work in your favour if properly used. Also, go and look at the market in 2012 and you will see that it was at a relatively low point – a good time for such a move – one of the reasons I bought the car then. As far as the next car goes, depends on market conditions if I do this again. But then, my current car will easily last another decade or more. I am a patient person.

@MOMO, I’m thoroughly impressed! You take risk & beat a highish interest rate loan 😉

Two things: (i) you must have a knack for making great equity choices! Since this method has almost guaranteed success for you, why not do one better by loaning the max on your property access bond (or make unsecured loan from these Direct Axis crowd) and make the same long-term profit? Bigger amounts = more profit, same approach.

(ii) Next time you’re again in a position to buy a car with balloon, PLEASE let us know what stocks you’re buying at the time 🙂 as it seems to be be a surefire bet 😉

@michaelfromKlerksdorp I appreciate that you send me smiley faces instead of emotion-laden, irrational and ill-tempered refutations :-). I don’t gamble but do take stock-based bets heavily in my favour and seek to buy stocks that will pay in the long run even if the market goes against me. I will let you know when I buy a car again – you may have to wait for as long as 5 years. The only stock tip I am prepared to make now, given current market conditions, is Naspers which is very cheap given its prospects. I would not use it to buy a car right now. Buy and put it away in the bottom drawer rather. Not only will it will survive a market crash but give you handsome returns over time. 🙂 🙂

Michael – why knock a person who understands the ropes on car financing and used balloon payments to service his debt and liquidate it

Good out of box thinking. With my luck I would have bought Steinhof.

Steinhoff would actually have worked reasonably as you would have bought in at about R25 in May 2012 and sold out in May 2017 at about R65 – all in the timing 🙂

With the markets as they have been I find it hard to believe you

This has less to do with low salaries and more to do with people wanting new luxury higher spec vehicles because of the prestige that goes with it. If you have to finance a vehicle, at least forego the balloon payment and reduce the finance period to as low as you can afford. Also, buy used and at a lower spec.

Demo models are a big saving.

I buy last year’s model in January and I buy cash. Go in, kick the tires and leave my email.The dealer usually waits a week or two. By the end of Feb I get a huge discount. Try it. Whatever you do don’t walk in and plonk down the cash.

Balloon Payments should be illegal – as simple as that!

Absolute rubbish – if you are financially astute you can use the balloon payment to your advantage – see momo’s option above – you need to manage your finances. You can also make arrangements with the bank to annually or half yearly make a direct deposit against your balloon payment – this out of any bonus/windfall that may occur. There are many ways to cut and slice these agreement but it is vitally important that the rules are establish prior to purchasing the vehicle

Oh rubbish G- balloon payments are a stupid way of buying a car and for idiots whose ego’s are bigger than their brains or wallets.

People are talking past each other here. Yes, balloon payments are stupid if used in the wrong way. But they can be used to your advantage if you are smart about it. Same thing with credit cards. Max out your credit and struggle to repay – stupid. Use the up to 55 days free credit and pay back immediately – smart.

I agree. I was always against baloon payments. I have recently moved to the USA, and was suprised how cheap purchasing a car is…only to find out the lease on my new Jetta is the same as a baloon. After my 36months I still owe 51% on the car, But with low payments, and trouble free motoring for 3 years. I could not pass this up. So for now im pro residule ! (I guess Ill check back in 3 yrs time) Note: my interst rate is like 3%, so it is not apples with apples

Balloon payments are simply ‘instant gratification,’ allowing people who really can’t afford a car at that price (and prestige!) level to buy it. The fact is that in your monthly installments you’re paying interest ON THE TOTAL AMOUNT INCLUDING THE BALLOON PAYMENT PART RIGHT FROM THE START. So balloon purchasing is truly a very costly way to buy a car. Only do it if you have such low self esteem that you must have a car that you can’t really afford. And you WILL pay dearly for your self-gratification in the long run.

Agree D. Stupid way to buy a car.

What utter nonsense its all about how you structure your purchase and knowing how the banks structure their financing. I still took my vehicle financing over 72 months but actually paid it off after 58 months based on knowing on what day interest would be charged and making a small lump sum payment 1 or 2 days earlier as interest is calculated on outstanding balance. Do your home work

99% of people who buy with a 35% balloon payment simply can’t afford to pay ‘lump sum payments’ throughout. And mostly don’t get the ‘windfalls’ referred to either. So you’re OK Jack, but the principle applies to the mass market: buying a car on a balloon payment is costly and stupid. End of story.

Whats more disturbing is the insistence of most dealers to finance this way.

There are kickbacks from financial institutions to upsell the deal to the best interest of the banks ( longest term biggest balloon) than whats the best interest to the consumer.

Some dealers are very reluctant to allow the buyer to source their own finance direct and insist that you uses there F&I person.

Some brands use this method to entrap you in there brand for your foreseeable motoring future

Not a word here on our runaway car prices. Many people simply do not have a choice but to go for a car of a certain size – that then leads to a balloon payment.

People have plenty of choices. They just don’t make the right ones. They buy the BMW x3 instead of the Rav4. Or the brand new car instead of the 2 year old car.

It’s simply our keep-up-with-the-Jones’ mentality. I’m pretty sure they understand that it’s going to cost them in the long run, they just don’t care.

Vehicle finance and along with it, balloon/res value structuring, is CRITICALLY IMPORTANT for our local motor industry to survive.

Mix it with successful marketing strategies from all manufacturers, and S’Africans’ absolute craze to MUST HAVE “the latest and greatest”, the car industry relies on that!

So to anyone always buying brand new (with balloon finance), we encourage you to continue, and you have a special place in our hearts as dealers.
Alternatively, if you’re those cheapskate buyers who only buy good used bargains (and in the process, unfairly abuse the 1st new car owner to bear the brunt of initial depreciation…shame on you!)

Don’t be selfish to save on good used cars, but always keep your new car dealer closest to heart. Think of us first. You never lose. It’s an investment you can drive… 🙂

That’s the spirit, Michael – live and let live. The way I do it everyone wins. The dealer makes money off me and can afford to send his children to school; and I make money on the stock exchange and get a shiny new car on the cheap. Three cheers for capitalism!


End of comments.





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