How much can you afford to spend on a car?

People are buying cheaper cars, opting for second-hand rather than new, and keeping their vehicles for longer. This is an economic reality, but not necessarily a bad thing. Cars are a depreciating asset and, over the past few decades, have become far more reliable on average. So while economic realities are forcing many people to stretch out the life of their cars, increased reliability is making it easier to do just that.

At the same time, however, many people are finding that these same realities are resulting in car ownership adding considerably to their debt burdens.  

Apart from those still lucky enough to get new cars provided or partially financed by their companies, an increasing number of people is buying used cars and
buying cars with a repayment term of 72 months, which is much longer than the historical norm, says George Simitopoulos, the CEO of carfin.co.za.  

The shorter the term, the quicker you pay off both the interest and capital, and many people paying off over a longer term end up having a significant shortfall, and then rolling it over into the debt on their next vehicle, he says. Before they know it, their debt repayments are unsustainable.  

One of the biggest problems is that, before applying for financing, people tend to look at what they can afford without taking everything into consideration, Simitopoulos says. This includes not only repayments on the purchase price, but also insurance, maintenance and expected fuel consumption based on how many kilometres are currently travelled.  

Banks generally recommend that the price of your car should not be more than 30% of your annual gross salary, and your monthly costs should be no more than 10%.   

Other rules of thumb are that people earning roughly between R10 000 and R20?000 a month should limit themselves to buying second-hand cars, those earning up to R50 000 should look at smaller new cars, while those earnings more could look at something a little more luxurious. Only those who earn over R150 000 a month should consider 4X4s or sports cars.  

“Banks tend to use about a third of income, some gross and some net,” says Simitopoulos. “We tend to find that about 25% of a salary should be used as a benchmark. That’s just related to repayments,” he says. “Insurance, fuel and other costs push it up to about 30%.”  

He says there has been an increase in sales of second-hand cars. “There has also been a huge reluctance to buy. We see a lot of people getting approved [for finance] reluctant to take the next step.”   

Generally, the bulk of buyers are those who need, rather than want, a replacement car.   

There has also been an increase in enquiries about refinancing and restructuring loans to alter interest rates and repayment terms and Simitopoulos says car owners should look at these options.

“Banks and car dealerships are incentivised according to whatever interest they charge you so the higher the interest, the higher the commissions. We estimate that a large percentage of people are overpaying, especially first-time buyers who are buying into instalments, not interest rates,” he explains.  

He says buyers should be aware that second-hand pricing is going up. New vehicle sales feed into the second-hand market a few years down the line, and because there are fewer new vehicles being sold, there is a decrease in second-hand stock and prices are going up. While it may seem like there are a lot of second-hand cars out there, these include rebuilt cars from insurance auctions, which are not necessarily in good condition.  

Simitopoulos suggests that owners hanging on to their cars for longer than they normally would have should look at extending their warranties.  

Automobile Association (AA) spokesman Layton Beard says potential car owners need to decide on their budget and stick to it. Many budgets are thrown out the window when the person gets into a showroom and sees the car of their dreams. “Identify what your budget is and don’t go over what your means are, and make sure you speak to the dealer about any potential extra costs.”  

He suggests that whether you are buying or leasing a car, make sure you understand the contract, including any warranty and maintenance terms.  

An AA safe car survey found that for people buying for the first time, who are generally young people or a parent buying a first car for their children, price is a big factor and they tend to neglect safety. He says such buyers must check that there are adequate safety systems in place as addressing this after buying the car leads to additional unexpected costs, not to mention safety risks.

This article originally appeared in the 11 May edition of finweek. Buy and download the magazine here.