Ever wondered how car finance works? We look at some of the things you will need in order to qualify for vehicle finance and the documents required. Look closer at affordability and what ballon and residuals are.
By Chad Lückhoff
Published: 5 October 2021, 13:37
It's no secret that cars in South Africa are expensive. A car purchase will be the second biggest, and sometimes the absolute biggest, purchase you make in your life, second only to buying a house. Very few South Africans are able to afford a new vehicle outright and pay cash for it. While this saves you money in the long run (we'll discuss that further down), a finance agreement is still a great way of getting into a new car.
Related:How to get the best car finance deals
There are several things you need to keep in mind before selecting to buy a car on a finance agreement and we will look at them below to help ensure that you don't fall into a hole that financially cripples you in the long run. While no one can predict the future, careful, honest consideration can help see you in a new car and enjoying it for years to come.
What is car finance?
Vehicle finance is a loan granted to you by a financial institution (a bank or similar) that pays for the vehicle you wish to buy and allows you to pay them (the bank) back over the course of several months. A finance agreement breaks down the purchase cost of the vehicle into manageable amounts that you pay back every month.
The financial institution grants you this loan on the condition that you pay back the amount owed with interest (a 'fee' that is added on to the total price). This is calculated at the beginning of the agreement and the monthly repayments contribute to this interest. Typical interest rates range from as low as 7% to as high as 18% and are calculated based on your own, individual credit score.
During this time, the bank will hold the title to your car but you get to use it as needed. You are responsible for the maintenance, upkeep, running costs and insurance on the vehicle. Once you have completed successfully paying off the loan, the ownership is transferred over to you and you own the car outright.
Comprehensive insurance is required by law when a vehicle is financed through a finance agreement with a bank or financial institution. Keep this in mind when working out the affordability.
Minimum requirements
Not everyone will qualify for vehicle finance and before you can even qualify, you need to meet a certain set of standards to be considered. Most financial institutions operate according to the following set of criteria. Applicants must be:
- 18-years old or older
- Be in possession of a valid driver's license
- A South African citizen or permanent resident
- Earn more than R7 500 per month
These are the basic requirements in order to be able to apply for finance. Meeting these requirements does not ensure that your application for finance will be approved though.
In order to be able to apply, you will have to furnish the following documents as well.
- Copy of a valid ID Document
- Proof of address
- 3 months bank statements (more if self-employed)
- Proof of income / recent payslip
I think I quality, what now?
If you believe that you qualify for vehicle finance, you need to complete one more step before running out to buy a car. This is the most difficult part of the process as it requires complete and utter honesty. If you are dishonest or inaccurate with this, you will be causing a substantial amount of damage to yourself - no one else. It pays to think carefully and be as honest as you possibly can be. This is the part where you will need to separate your heart from your head, acknowledge what it is you want, versus what you can afford.
You will need to work out your affordability. For this, you will calculate how much you can afford to spend on a car every month. You will start with your net salary (the amount that gets deposited into your account every month) and deduct your monthly expenses. This includes everything that you spend money on in a month, from school fees to food, rent and other service providers. The amount that you are left with is an indication of what you can afford.
While this amount may look attractive, you will have to factor in the additional cost of insurance, fuel and running costs of the vehicle before you will know how much you can afford to repay on a finance agreement every month. When you apply for finance, the financial institution will look at your affordability and work on an application that is somewhat less than the amount you have leftover. This leaves some wiggle-room should your life circ*mstances change.
Application process
If you are buying the car through a dealer, there will be a financial advisor on hand to help you with the application process. They will work out what the monthly repayments on the car that you want is and help you apply to several institutions for finance. You will need to supply the documents listed above as well as the completed application form that will ask about your affordability. As a loose rule, your monthly instalments should be no more than 30% of your net salary.
If you are buying the vehicle through a private sale, you will have to apply with the bank yourself. It's a good idea to apply at the bank that you are with for the vehicle finance but you're also allowed to try other institutions as well. Copies of additional documents will be required, such as the vehicle's registration document. It's worth noting that banks may be reluctant to finance vehicles older than 10-years or will only approve finance if the older vehicle has a 3rd party warranty in place. They will also require that the vehicle cost more than R50 000.
Balloon or residual payments
One of the ways to bring the monthly instalments down on a particular vehicle is to factor in a balloon or residual payment. This is an amount that is kept back from the initial price of the vehicle so that finance can be arranged on the balance. eg: If the car costs R100 000, you can get a balloon/residual of up to R30 000, so that you only have to pay back the instalments on R70 000 plus interest.
At the end of your finance term, the balloon/residual is still owed to the bank though. At this time you will have the option of paying it back in a lump sum (the full R30 000), financing the amount with interest, or returning the car to the bank/financial institution or trading the car in, should you wish to enter another finance agreement.
Wedo notrecommend balloon or residuals as these compound the amount of interest you pay on the vehicle at the end of the term. While attractive in the beginning and allowing you to get into a more expensive car, it's merely delaying the inevitable and could possibly lead to financial difficulties.
