Up until late last year, car buyers have enjoyed low interest rates, extremely low vehicle price inflation, extended finance periods and an incredibly competitive market, all uniting into reducing monthly car instalments and improving affordability.
But with new car price increases outpacing consumer price inflation (CPI), average vehicle finance periods already close to 72 months and expectations of more interest rate hikes, the avenues to improved affordability are limited.
This could intensify the temptation to choose a balloon or residual payment (an inflated payment at the end of a vehicle finance contract) and reduce monthly instalments.
Retailers have caught on. Most car magazine ads include balloon payments options, ranging between 25% and 60%.
What the data shows
Wessel Steffens, head of Absa Vehicle and Asset Finance, says balloon payments now make up 19% of loans, up from 16% a year ago.
The average balloon payment is between 25% and 30%.
Rudolf Mahoney, head of research at WesBank, says since January last year balloon payments have grown 20% and their size has increased in line with inflation at around 6%.
Mahoney says the main driver is the buyer’s reduced monthly instalments.
Nicholas Nkosi, head of Vehicle and Asset Finance Personal at Standard Bank, says 15% of the total applications are with balloon payments.
He did not want to divulge statistics around the percentage of applications approved with a balloon payment.
A balloon payment delays the point in the finance period where the outstanding loan amount will be equal to the trade-in value of the vehicle (the break-even point). This means that some customers might find themselves having to pay in an additional amount on their loan, should they trade in their vehicle before the break-even point.
In some instances this break-even point might only be reached a year after the average trade-in term of around three years.
Steffens says the downside of a balloon payment is that it is interest expensive.
It essentially means that some of the outstanding capital is transferred to the end of the agreement and interest would be calculated on a higher outstanding capital amount.
He says it could be difficult to trade out of the vehicle in the early part of the agreement as the capital redemption is slowed by the balloon payment.
It is really important that customers consider an insurance product that covers the gap between the value of the vehicle and the insured amount.
Most institutions offer a product called extended cover or top-up that will protect customers in these instances.
Nkosi says it is essential for customers to understand the impact of a balloon payment.
In some cases buyers will take ownership of the vehicle after paying the balloon, while in other cases – such as vehicle rental agreements – they would just hand back the vehicle without paying the residual.
The handful of people who do not choose to trade in their vehicle at the end of the finance term but to settle the balloon payment, should ensure that their cash-flow allows for such a disbursement.