Vehicle Finance And Balloon Payments

It’s a popular way to sell vehicles these days; the balloon payment. The sales and marketing will tell you that it brings down your monthly installments and at the end of the finance term, the dealer will buy back your car to cover that balloon payment (guaranteed, terms and conditions apply) or you just refinance/settle that outstanding amount. Sound good?

This payment is also known as a bullet payment: because it’s like a bullet to the head. Sound harsh? Not when you know what’s really going on in the maths. And keep in mind, the residual offer is also made available to folk who are “high risk” or simply cannot afford the regular payment. In other words, people who are already financially marginalised. Let’s have a look see…

Note: numbers have been rounded to make the reading easier…

The list price on a vehicle is R330 000. Terms are over 60 months. Interest rate: 11.5%. On a regular loan, you can expect to pay back R7200/month. Once you’re done paying for the car, you’ve paid back R435 453.63 (or financed R105 500 in interest over the 5 years). Ha, you think that’s bad?

Let’s apply a 30% balloon payment to the same offer. Your balloon payment is R99 000. Your monthly payment is now down (the “good” news) to R6 000/month. Over the term, at that repayment, you’ve paid back R361 800 (or what might look like R31 800 in interest). Wow. Sounds great! BUT, you still owe R99 000. Now even if you paid off that R99 000 in one go, you would have paid R130 800 extra for the same car. So where does it all add up…?

That R99 000 payment at the end of the term is discounted back to today’s value (at the deal’s terms and interest rates) to a value of R55 860. The loan that you actually end up applying for is NOT R330 000 – R99 000. It is in fact R330 000 – R55 860, a value of R274 140. That’s why your repayment is lower- but not that low. That R99 000 represents a “discount” you get today but you still pay interest on it until you pay it off. Effectively, you’re financing 2 loans. You have actually financed R87 600 in interest (compare that to R105k on the traditional loan)

One for R274 140 at R6 000/month, another for R55 860, except that in case, the monthly payment is deferred in lieu of paying the whole loan off in one go at the end. Still sound good? Of course, if you have the extra R1200/month lying about, pay it in, but you might need to stipulate wether this is a payment towards interest, capital or the residual. Getting complicated?

Now, unless you have that amount lying around after 5 years of paying a premium, you’re probably going to need to refinance that R99 000. The terms and interest of that loan don’t exist today and still have to be negotiated. Let’s assume you manage to refinance that R99 000 on the same terms (unlikely), that’s another 5 years at R2 200/month for a grand total of R130 600.

In all, your R330 000 car, with a 30% residual refinanced, now costs you R361 800 + R130 600 = R492 400 over 10 years. The traditional loan is R435 500 over 5 years.

Now, just looking at the whole deal, you can decide for yourself wether that’s worth it or not. Depending on where you’re investing, spending, saving, it might actually be a worthwhile avenue. Or it might not.

Just keep in mind:
* you’re paying off two loans when you opt for a residual value
* the residual amount represents a discount you receive today that’s already been compounded with interest
* you’re effectively applying for finance at the list price less the discounted price
* the dynamics of the interest on the residual are hidden from view

Happy financing!


zaFin for BlackBerry

At last, a version for the BlackBerry has been released and ready for general public consumption. Make some good decisions this year- based on numbers and data- not just emotional “got-to-have-x” or even more dangerous hype-based “woohoo-the-recession-is-over-we-can-spend-now” motivations. take the time to think it over a little… or use zaFin.


Put It In the Bond?

If you’re servicing a mortgage at the moment, and you happen to come into some money, the “best” advice you’re probably going to get is: “put it in your bond”. Not bad advice, i guess, but i’m not so sure it’s the “best”.

**DISCLAIMER: I’m NOT a financial advisor; am not pretending to be one; and certainly not qualified to be one. But i can kinda do the numbers, so this looking at it purely from a mathematical perspective.

When it’s not really the “best” advice is when you are servicing other debt, at higher interest rates. Then the numbers say: kill that debt first, and _then_ look at the mortgage. So if you’re servicing a credit card, overdraft or vehicle finance (which can typically be higher than prime) and your mortgage is sub-prime, service the higher first.

But more personally, i recently faced the opportunity of trading in my vehicle for a newer one (which would have been nice) and i was figuring out what to do with the trade-in amount and work out where it would best pay dividends. On an aside, i’m of the opinion that buying a vehicle is NOT a financially smart move at all- no matter how you try slice the numbers. You will always lose (and i’m not referring to collectors’ classics). So look after your car- treat it nice, drive nice, service it regularly so you can leave it in your will. After all, it’s __just__ a car, right 😉

So down to the maths… Note: the numbers have been changed slightly to protect the prudent.
New car: R150k at 15.5% APR over 60 months.
Existing debt: R640k mortgage (±30 months into the schedule) at 14% APR over 20 years.
Trade in on car: R50k. What to do with the R50k? A) Plough it into the bond. B) Use 100% of it as a down payment on new car. A or B, what do you do? The “best” advice i received was plough into the bond and save thousands in interest on the bond! Uhuh. That’s half the truth.

As a down payment on the new car, I reduce the repayments from R3.6K to R2.4K, and end up saving, in effect, R44k in interest over the term. Not bad, not great.
In the bond, i reduce the interest _over the same term_ by R33K. Worse. But not a surprise. And that’s the important part here: the same term. 60 months. You see, over the remainder term of the mortgage, that advance payment will save you A LOT! But now you’re comparing a value of money of two different terms: 60 months versus N years on the mortgage, so don’t be too surprised if you draw bogus conclusions. Afterall, once you’ve finished paying off the car, you’re R3.6k deeper in the pocket which you can then plough into the mortgage anyway.

So, on face value, it’s more favourable, over the same term, to service the vehicle as quick as possible and then see to the lower interest obligations. But there are better options… which is the other half of the truth: discipline.

Add in some fiscal discipline into the mix, and suddenly your options are wild. For example…

Put down the down payment on the car, saving an extra R1.2k in repayments each month on the car, but then put the saving into the mortgage over the same term. Suddenly you start to save R64K in interest. Mmmm… Or…

And then there’s this. Which really was the best option (Thanks, A)…

Take your old car for a shmancy valet at about R200, pretend it’s new and “pay for it” anyway at R3.6k per month. Now you’re saving close to double your previous best!

The bottom line is; if you’re in the market for a car and can afford X, but you’re servicing other debt, service that debt first- forget about the car*. Unless it’s an absolutely necessity (and looking better than the Jones’ is not a necessity- i checked) you probably don’t need it.

*Forgetting about the car, probably anywhere in the world, is really hard to do though. In South Africa, households spend a disproportionate amount of their disposable income on vehicle financing, which says a lot about how we feel about our cars. Somehow, cars have so (too) much appeal. So much so that having 4 reliable wheels is just never enough. There’s always going to be something really “cool” about a car that makes you just wanna have it. And the price tag is just irritating. Can you say X-Trail… or Fortuner? 🙂