Need a new car? These are the payment options available to you

Consumers have various payment options when buying a car and each of these options have its own benefits and challenges.

Braai-side conversation often turns to a debate about the merits of buying a new car versus a used one and paying cash versus getting financing. Inevitably, someone will raise the point that “a car is not an asset”.

However, that is actually wrong says Ernest North, co-founder of insurance company Naked. “A car is an asset, although it is a depreciating asset that loses value over time. In most cases, a car is not an investment.”

North says a car is an asset you spend money on, whether you choose to own it, or just get access to it by leasing or renting it. “If you decide to own the car, you can buy it with cash or through financing. What is true is that a car is more like a living expense than an investment that will grow.”

For most people a car makes up a significant portion of how they spend their disposable income and it is wise to think carefully about how to make that spend work the hardest for you and be in line with your financial and lifestyle goals.

“Think about your car and how you will pay for it in the context of your financial plan. This includes how the way you finance your car will affect your budget, lifestyle and long-term wealth.”

ALSO READ: Keep this in mind when you buy your first car

Paying cash for your car

The simplest way to buy a car is to pay cash if you have the money available in your bank account. You can simply transfer the money with an electronic transfer to the dealer or the person you buy from and fetch your car.

However, most people cannot afford to pay cash for a car and some would prefer to get a nicer or newer car than they can afford to buy cash.

North says the benefits of paying cash when you buy a car include:

• You do not pay interest on a depreciating asset.
• You do not need to worry about upcoming balloon payments.
• There are no constraints on your use of the car, such as mileage limitations.
• You are not tied to a financing period and not forced to rethink your ownership of that car at a set time in the future.

The challenges, on the other hand are:

• It limits your choice of vehicle to what you can afford to pay upfront.
• Paying cash for your car ties up money you might want to use for other purposes like a deposit for a house (in investment terms, this is called “opportunity cost”, where you lose the opportunity to use your money elsewhere).
• You probably will not be able to enjoy that new car smell as often as someone who leases or finances their vehicle.

TIP: If you are a bit more established, one option you can consider is to draw money from your access bond and using it to pay cash for the vehicle. Interest rates on home loans are generally far lower than for car loans and you can pay back what you borrowed as and when it suits you. Make sure to do your research or speak to a qualified financial advisor to find out if this could benefit you.

ALSO READ: Used car or new car? What you need to know before buying

Getting a car loan

If you cannot afford (or decide not) to pay cash for a car, you can apply for a loan from the bank or car dealer that you pay back over four to five years. Each month, you will pay off some of the loan plus interest. The exact monthly repayment will typically go up and down in line with the interest rate. With a loan, you generally also pay a deposit and the higher the deposit, the less interest you will pay over time.

North warns that some car loans end with a big, one-time payment (called a balloon payment) to settle the loan. A balloon payment option can make your monthly payments more affordable by reducing your repayment on the capital portion of the loan. However, you will still need to pay interest on the full amount you borrow across the course of the loan.

The benefits of getting a car loan are that it:

• Makes a car affordable even if you do not have enough cash.
• Allows you to buy a car that is a bit nicer and more reliable if you are strapped for cash.
• You can drive the car as much as you want without worrying about mileage limitations.
• Once the loan term is over, the car is yours to sell, keep or trade in.

However, buying a car this way has these challenges:

• Interest payments mean you are effectively paying much more for the same car. If you finance a R250 000 car with a 10% deposit over five years at a 13% interest rate, you will pay an eye watering R82 000 in interest over the full term.
• If you want the contract to end early, you usually pay a penalty.
• The balloon payment. If you choose to go this route, you will have to find a substantial chunk of change at the end of the loan period.

TIP: In some cases, vehicle brands offer a “guaranteed future value” that the dealer will pay for the car if you no longer want it at the end of the term. But generally, that sum is just enough to cover the balloon payment. Therefore, it is not going to provide the deposit for your next set of shiny new wheels. There can also be terms and conditions like a mileage limitation and other service, maintenance and care requirements to get a “guaranteed future value”.

ALSO READ: Get up to speed: Your rights when buying a car

Lease-to-buy a car

Many vehicle brands offer leasing deals for new vehicles that enable you to transition into buying the car. Lease-to-buy agreements provide for you to buy the car for a guaranteed future value when the lease period is over, or to start a new financing deal. Generally, you will be able to pay a deposit upfront, which reduces your monthly lease payment as well as the future purchase price.

The benefits of buying a car this way, include:

• Monthly payments may be lower than if you use conventional finance.
• Lease-to-buy options give you access to a car if traditional financing is not successful.
• This approach might enable you to get a new car every four to five years.
• Some deals include servicing and insurance in the monthly cost.

The challenges of buying a car this way are:

• The contract is subject to mileage limitations and other care requirements. If the car is not in a good condition, you will pay a penalty at the end of the lease period.
• There are usually significant penalties for breaking the lease agreement early.
• Lease-to-buy agreements are not very flexible and you have to use a specific finance provider.
• You will usually have to refinance or pay a hefty final balloon payment if you want to own the car at the end of the term.
• If you always lease your cars, you will never own a vehicle of your own or get a break from paying a large sum of money each month for access to a car.

ALSO READ: Four steps to avoid buying a stolen car

Car subscriptions – the new way of buying a car

North says South Africans do not have as many options to choose from as consumers in other countries. The idea is that you can ‘subscribe’ for access to a car in the same way you pay for Netflix. Planet42 is one example of a company that offers second-hand cars on subscriptions.

It is usually a month-to-month contract and you can return the car at any point after six months, paying only a one-month cancellation fee. There is no fixed term for how long you pay the monthly rental fee. Depending on the provider, the subscription might include insurance, maintenance and servicing.

The benefits of buying a car on subscription are that it:

• Offers access to a car if you have a bad (or no) credit record and cannot get financing.
• It is a much more flexible option than traditional financing.
• You do not have to worry about financing or trade-in values.
• An all-inclusive monthly fee makes it easy to see what you spend on your vehicle.

However, the challenges are that:

• The monthly cost may be higher than leasing a car or buying one outright.
• Some providers might have a mileage cap.

ALSO READ: What to know when buying a car ‘new’ or ‘new new’

Long-term rentals

Long-term rentals are similar to subscriptions, but there is usually a set maximum rental term. Many of the same companies that offer short-term car rentals (like Avis or Europcar) also offer options to rent for more than 30 days at a time at a preferential rate.

The benefits of renting a car long term are:

• It is perfect if you only need a car for short-term use, such as when you are in a different city for three months for work, do not need a car for six months while you are seconded overseas and then want one for a month-long road trip.
• The rental bill stops when you return the car after the agreed rental period.

The challenges, on the other hand, are:

• Long-term rental is usually the most expensive way to pay for access to a car.
• You have less control over the type of car you drive. A rental agreement is likely to be for a “VW Vivo or similar”.
• Mileage restrictions generally apply.

ALSO READ: Buying your first car? Here is some practical advice

How to choose the right option

North says deciding how to pay for your car comes down to your financial situation and long-term plans. Some of the questions you can ask yourself include:

• Do you qualify for credit to lease or finance a vehicle?
• How often do you want to get a new car?
• How much cash do you have in the bank? Is there a better investment opportunity for it than spending it to buy a car for cash?
• Are you expecting any changes in your financial life, whether it is the possibility of retrenchment or the possibility of a promotion?
• How emotionally invested are you in the concept of owning a car?

“Whatever you decide, do not forget to budget for the full cost of car ownership. In addition to the cost of the car itself, you will have to pay for fuel, insurance, maintenance and repairs. If your car is financed, it is wise to budget for the interest rates to increase. Also, do not forget to get insurance for your new wheels to protect your investment in your new baby.”