The “cheap” car finance option that can cost you a lot more down the line

The price of new cars is increasing at an alarming rate, with households becoming increasingly reliant on lengthy finance plans to keep up.

The average vehicle finance agreement in South Africa now spans 72 months (six years), and longer 84-month and 96-month plans are growing in popularity, according to data from Lightstone Auto.

With this in mind, many consumers may be tempted to take out a balloon payment, which is a financing option that promises to drastically reduce the monthly repayments on a car.

While it can be a useful option when used correctly, motorists need to be aware of the risks that a balloon payment can present.

WesBank noted that balloon payments are among the least understood financial services and can end up being far more expensive than some anticipate.

“Understanding how balloon payments work, and what to do if you’re struggling to meet one, can improve your financial wellbeing,” it said.

“A balloon payment on a vehicle is when you pay a smaller monthly instalment but agree to pay a large lump sum at the end of the finance agreement/contract.”

WesBank illustrated the difference that a balloon agreement can make to a person’s monthly repayments, and how much they will have paid at the end of the contract.

In its example, a R350,000 car is financed over a 60-month period at an interest rate of 11.5% per annum.

With no balloon, the individual would pay R7,700 per month, ultimately paying a total of R462,000 when their term comes to an end.

With a 20% balloon, the instalments are lowered to R6,840 per month. However, the person is still required to pay R70,000 at the end of the contract.

Once the balloon is factored in, the individual would have paid R480,000.

WesBank said that the instalment reduction is meaningful, dropping by roughly R870 per month in this example.

“Over five years, that offers some cash flow relief in a household budget. The challenge arises when that final payment isn’t factored into a longer-term budget.”

The finance house commented that it can sometimes seem easier to determine whether monthly instalments are easier to afford when purchasing a vehicle.

“A lump sum due in 48 or 60 months’ time can feel abstract, until it isn’t. Neither option is inherently better.”

“The right choice depends on your financial circumstances, your planning horizon and what you intend to do with the balloon amount when it arrives.”

When it’s safe to use a balloon payment

WesBank said that a balloon payment makes sense when consumers need more flexibility with their monthly budget.

However, it stressed that individuals also need to look beyond the immediate payments to consider the impact on their long-term budget.

“Consumers who understand what’s coming and plan accordingly are in a far stronger position than those who are surprised by it,” said Lebogang Gaoaketse, Head of Marketing and Communication at WesBank.

Gaoaketse said that there are two points where motorists typically run into issues. The first is simply not setting money aside over the course of the agreement to meet the balloon amount.

“If you know from the outset that a lump sum will be due, treating it like a savings target, even informally, gives you options when the time comes.”

These options include a refinance, a trade-in, or a cash settlement.

The second issue is the response to financial difficulty. Gaoaketse explained that when payments become hard to meet, the instinct for many people is to go quiet and hope the situation resolves itself before it becomes a formal problem.

“This is understandable, but it’s also where small difficulties can become larger ones.”

“It’s worth knowing that missing a single payment does not trigger immediate repossession or legal action. Financiers have processes in place precisely because arrears happen, and the goal on both sides is to find a workable path forward.”

WesBank said that motorists should take the following steps if they are concerned about an approaching balloon payment:

• Contact your financier as early as possible. The sooner a conversation starts, the more options are available.
• Be transparent about your situation. A financier can only tailor a solution to circumstances they fully understand.
• Ask about restructuring or refinancing. Depending on your agreement and financial position, there may be ways to manage the balloon amount that aren’t immediately obvious.
• Don’t wait for a formal notice to act. Proactive communication is almost always met more favourably than a reactive engagement.

The finance group stressed that balloon payments can be useful under the right circumstances, provided they are understood and planned for.