Johannesburg - "I need to buy a new car of about R300 000. The depreciation of the car really hurts. What would be the best possible way to finance the car?" John asked Fin24.com's Money Clinic recently.
"I can afford to pay cash, but never I'm sure if this makes sense."
A car is probably the worst investment you can make. By some estimates, new cars often lose almost 30% of their value in the first year. After two years, a new car may be worth half its original price and all models continue to lose a chunk of value every year.
This should underscore the main consideration when buying a car: don't waste any money on it. Buy something you can comfortably afford.
But how should you pay for it?
Cash:
If you pay for it in cash, you will lose a big chunk of it because of depreciation. But at least you won't also have to pay R88 400 in interest, monthly administration fees plus an once-off initiation fee of some R1 100 (on a 54-month finance deal with a 10% deposit and an interest rate of 13%).
What about the opportunity cost - can you invest the money elsewhere and get a better return? Unfortunately, finding an after-tax, real return that will beat the interest and charges will be hard.
If you have the money, the best option is to pay cash, said Ian Beere of Netto Financial Services. But you need to make sure that just because you have a certain amount, you don't feel the need to blow it all and spend more than you should.
"The bottom line is that the less you spend on a car and the longer you keep it, the wealthier you will be - although conditions apply."
As local car dealers struggle through one of their worst downturns ever, paying cash also has another benefit.
"Paying cash is a better option as dealers prefer it and the client can thus look for a discount on the purchase price," said Angus Thompson of Wheels24.co.za.
Also, it is much more straightforward to sell a car paid for by cash. When you want to sell a vehicle before the loan amount is settled, it can be a hassle to get all the documentation, including the title, from the bank.
But when you pay with cash, you need to be extra careful about who you are buying from. Banks are experts in making sure a car's value is market-related, that the vehicle is not stolen and that there is no loan amount still outstanding from the previous owner.
And if you've spent all your savings on a car, you won't have any cash on hand for emergencies. This could force you into debt.
Instalment sale:
If you choose to pay for the car in monthly instalments, you'll fork out about R362 000 (including charges and fees) over the course of 54 months (with a 10% deposit and an interest rate of 13%).
Another way of doing it is by using money available on your home loan facility, which usually has a lower interest rate. You may end up saving almost R20 000 if you could pay interest of 11%, instead of 13%. But then you have to force yourself to pay off the loan within a set timeframe - and not stretch it over the term of your home loan.
Balloon payment:
This option means you pay only a part of the value of the car at first. At the end of the loan term, you're left with an amount payable. You can settle it by selling the car (if the value of the car hasn't fallen too much), or by paying it off in monthly instalments, usually over a period of 12 months.
With a balloon payment of 40%, and if you pay off the outstanding amount within 12 months afterwards, the car may cost you more than R400 000.
It is really important to ensure that balloon value is lower than the expected vehicle price when the loan agreement is over.
Leasing:
Following the introduction of the National Credit Act - which allows for much more flexible payment terms (no deposit, balloon payments etc) on instalment sales - leasing is these days primarily used by people who use their cars for business purposes.
When leasing a vehicle used to generate income, you are allowed to deduct your monthly payment on the vehicle from tax. You won't have to pay a deposit and usually your monthly payments may be less than with an instalment sale.
At the end of your contract - which can be over a maximum of 72 months - you can choose to take ownership or return the car to the bank. You can also continue to use the asset for a reduced rental amount, or no rental.
In effect, leasing agreements are now similar to instalment sales, said Marcel de Klerk, managing executive of Absa Vehicle and Asset Finance.
Renting:
Rental agreements are a lot like leases - but you don't ever take ownership and where the whole VAT amount is capitalised at the start of a lease, it is spread out over the term of a rental agreement and deducted every month.
Many high-income earners who want to drive a new car every two years go for rental agreements.
Basically, you agree with the bank to pay a percentage of the car's price over a specified period - say 50% over two years.
At the end of the two years, you return the car to the bank, which takes on the depreciation risk and has to sell the car.
However, the bank will usually impose restrictions on use, like the maximum kilometres allowed over the lease term. You will have to pay penalties on any extra mileage. You will also need to service the car at regular intervals, and pay extensive insurance.
Both rentals and leases allow buyers who use vehicles for business the opportunity to structure their finances, said De Klerk.
You can structure your monthly payments, which can be deducted from tax, to suit your taxable income situation.
However, if you have the funds - and won't use the car to generate an income - buying the car with cash is a no-brainer, said De Klerk. You'll struggle to find an investment that will yield the same return.
John would also be well advised to look at one- and two-year old cars (with up to 12 000km on the clock) at the moment, De Klerk added.
There are many great cars in the market due to a current dearth of buyers in the price range above R250 000. Buying a used car at the start of a new year, when the book value depreciation has just taken place, offers additional value.
- Fin24.com