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Port Elizabeth - It is very easy to avoid all the tricks which make debt look more attractive than what it really is: Understand how credit works.
Most people will dig a bit deeper when they see an advertisement that promises a car loan at 0% interest, or driving a R2.5m Ferrari for only R3 000 per month. Or if they can get R10 000 cash back when buying a new car, or get a whole lot of accessories free when picking up their new double cab.
A promise of zero deposit and low payments is also not as attractive as what it might look at the first glance.
A lot of people will not stop to ask why the bank suddenly became so friendly to stop charging interest or why the dealership on the corner starts to dish out very expensive tow bars and mag wheels for free.
A quick look at the components of a loan will clear up these mysteries. In fact, the whole global financial meltdown would have been adverted if the world took five minutes to look at basic components of the so-called sub-prime debt agreements.
Any loan, debt agreement or credit facility has a few basic components: the loan amount, the interest rate payable on the loan, the term of the loan and the required monthly instalments. Sometimes deposits and residual values (balloon payments at the end of the loan period) form part of the sum. Fiddle with any one of these, and the rest will change.
For example, if you want a zero or low deposit, you’ll end up with higher instalments, or more instalments, or a bigger residual at the end of the period.
Let’s look at the different tricks:
Offers of interest rates way lower than current rates
Just about all the major vehicle brands in SA have some time or another offered “special” low interest rates. Everybody can buy a car at prime less 5%, at only 2% interest or even at 0%. Advertisements of these schemes usually imply that the manufacturers or dealerships are subsidising the interest payments, which is not true.
And we know that banks will never lend out money for nothing. They obviously get their interest somewhere else, usually by increasing the price of the car with the exact amount that would have been paid in interest over the term of the loan. They won’t say that aloud, they simply do not offer the just-about-standard discount everyone can negotiate.
Instalments won’t increase if interest rates increase
When interest rates go up, the cost of using the bank’s money to drive a new car goes up. If instalments do not increase, something else is likely to increase. This is because the basic formula to calculate instalments is set in stone.
One way is to collect the higher interest due is to simply increase the term of the loan by adding a few more payments. Your repayment terms suddenly increases to 51 months instead of the original 48 months. Go look again, it is there in the very small print of the debt agreement.
A second method to ensure that instalments never change is to price expected increases in interest rates into the calculation right from the start. While other clients pay 8% interest on their loans, which will go up if interest rates increase, you pay 10% right from day one with the guarantee that instalments remain unchanged. And maybe a little monthly administration fee for the “service”.
No need to pay for the first 6 months
Once again, the friendly dealer is not going to let you drive his car around mahala for 6 months, and neither did Father Christmas acquire a majority interest in any of our banks during the last few weeks.
In this case the debt agreement still makes provision for the same number of payments than an agreement which requires the first payment at the end of the month. But now the payments are a bit higher, because the interest on the extra 6 months has been added to the outstanding balance…
Zero deposit, or low instalments
Drive a car without putting down a deposit, and it even includes registration and licensing fee. Or the premiums are so low that I just could not refuse. Shop around and you might find a deal which offers both a low deposit and low instalments.
Let’s introduce Mr Residual, who you will get to meet 60 months later when you need to pay that last instalment. This instalment is not the low R2 999 per month for such a beautiful German luxury saloon, but a monster of R112 000.
If the deposit and/or instalments are lower than normal, the debt formula must compensate somewhere else. At times, motor manufacturers sit with finance companies and construct finance arrangements with residual values of up to 40% of the original purchase price.
In reality, the full purchase price goes into the dealer’s bank account the day before he delivers your new car and you pay interest on the residual for the next 5 years or whatever the term of the loan. This is really a very expensive way to reduce the deposit or get those instalments lower.
A Ferarri for R3 999 per month
A few years ago, Future Fin (for a while in bed with Wesbank Finance) employed all the above tricks and a few more to offer multi-million rand cars like a new Ferarri, Porsche or Aston Martin for ridiculously low instalments.
The way to get the instalments so low was a high deposit of 25% and an even higher residual at the end of the term – up to 85% of the original purchase price.
The underlying assumption of the finance package was that these supercars increase in value year after year and that their value increased so much that the balloon payment at the end of the period would be small relative to the value of the car at the time.
Unfortunately, things did not work out too well for either the company or its clients. The first reason was that the rand started a long bull run against other currencies, which meant that the value of these very expensive imported cars did not increase as fast as in the past in rand terms.
In addition, manufacturers of all these upmarket marques seemed to have changed their overall business strategy at the same time. They all increased production numbers of these previously very exclusive sport cars to such an extent that they were not that exclusive any more. The result was that anybody could buy a brand new and much improved Porsche at a lower price than a 5-year old version with a huge balloon payment.
The cheapest debt
The cheapest debt - whether for a new car, a house or scuba diving gear – is the one where you put down the maximum deposit and opt for the shortest possible repayment term. Avoid residuals and try to pay more than only the minimum instalment.
* Ever been a victim of a debt trick? Share it here.
- Fin24
Help us help you by taking our second annual Debt survey and you could win R3 000, or add your voice by sharing your debt experiences, debt-busting tips and insights. Have a question? Ask our experts.
Most people will dig a bit deeper when they see an advertisement that promises a car loan at 0% interest, or driving a R2.5m Ferrari for only R3 000 per month. Or if they can get R10 000 cash back when buying a new car, or get a whole lot of accessories free when picking up their new double cab.
A promise of zero deposit and low payments is also not as attractive as what it might look at the first glance.
A lot of people will not stop to ask why the bank suddenly became so friendly to stop charging interest or why the dealership on the corner starts to dish out very expensive tow bars and mag wheels for free.
A quick look at the components of a loan will clear up these mysteries. In fact, the whole global financial meltdown would have been adverted if the world took five minutes to look at basic components of the so-called sub-prime debt agreements.
Any loan, debt agreement or credit facility has a few basic components: the loan amount, the interest rate payable on the loan, the term of the loan and the required monthly instalments. Sometimes deposits and residual values (balloon payments at the end of the loan period) form part of the sum. Fiddle with any one of these, and the rest will change.
For example, if you want a zero or low deposit, you’ll end up with higher instalments, or more instalments, or a bigger residual at the end of the period.
Let’s look at the different tricks:
Offers of interest rates way lower than current rates
Just about all the major vehicle brands in SA have some time or another offered “special” low interest rates. Everybody can buy a car at prime less 5%, at only 2% interest or even at 0%. Advertisements of these schemes usually imply that the manufacturers or dealerships are subsidising the interest payments, which is not true.
And we know that banks will never lend out money for nothing. They obviously get their interest somewhere else, usually by increasing the price of the car with the exact amount that would have been paid in interest over the term of the loan. They won’t say that aloud, they simply do not offer the just-about-standard discount everyone can negotiate.
Instalments won’t increase if interest rates increase
When interest rates go up, the cost of using the bank’s money to drive a new car goes up. If instalments do not increase, something else is likely to increase. This is because the basic formula to calculate instalments is set in stone.
One way is to collect the higher interest due is to simply increase the term of the loan by adding a few more payments. Your repayment terms suddenly increases to 51 months instead of the original 48 months. Go look again, it is there in the very small print of the debt agreement.
A second method to ensure that instalments never change is to price expected increases in interest rates into the calculation right from the start. While other clients pay 8% interest on their loans, which will go up if interest rates increase, you pay 10% right from day one with the guarantee that instalments remain unchanged. And maybe a little monthly administration fee for the “service”.
No need to pay for the first 6 months
Once again, the friendly dealer is not going to let you drive his car around mahala for 6 months, and neither did Father Christmas acquire a majority interest in any of our banks during the last few weeks.
In this case the debt agreement still makes provision for the same number of payments than an agreement which requires the first payment at the end of the month. But now the payments are a bit higher, because the interest on the extra 6 months has been added to the outstanding balance…
Zero deposit, or low instalments
Drive a car without putting down a deposit, and it even includes registration and licensing fee. Or the premiums are so low that I just could not refuse. Shop around and you might find a deal which offers both a low deposit and low instalments.
Let’s introduce Mr Residual, who you will get to meet 60 months later when you need to pay that last instalment. This instalment is not the low R2 999 per month for such a beautiful German luxury saloon, but a monster of R112 000.
If the deposit and/or instalments are lower than normal, the debt formula must compensate somewhere else. At times, motor manufacturers sit with finance companies and construct finance arrangements with residual values of up to 40% of the original purchase price.
In reality, the full purchase price goes into the dealer’s bank account the day before he delivers your new car and you pay interest on the residual for the next 5 years or whatever the term of the loan. This is really a very expensive way to reduce the deposit or get those instalments lower.
A Ferarri for R3 999 per month
A few years ago, Future Fin (for a while in bed with Wesbank Finance) employed all the above tricks and a few more to offer multi-million rand cars like a new Ferarri, Porsche or Aston Martin for ridiculously low instalments.
The way to get the instalments so low was a high deposit of 25% and an even higher residual at the end of the term – up to 85% of the original purchase price.
The underlying assumption of the finance package was that these supercars increase in value year after year and that their value increased so much that the balloon payment at the end of the period would be small relative to the value of the car at the time.
Unfortunately, things did not work out too well for either the company or its clients. The first reason was that the rand started a long bull run against other currencies, which meant that the value of these very expensive imported cars did not increase as fast as in the past in rand terms.
In addition, manufacturers of all these upmarket marques seemed to have changed their overall business strategy at the same time. They all increased production numbers of these previously very exclusive sport cars to such an extent that they were not that exclusive any more. The result was that anybody could buy a brand new and much improved Porsche at a lower price than a 5-year old version with a huge balloon payment.
The cheapest debt
The cheapest debt - whether for a new car, a house or scuba diving gear – is the one where you put down the maximum deposit and opt for the shortest possible repayment term. Avoid residuals and try to pay more than only the minimum instalment.
* Ever been a victim of a debt trick? Share it here.
- Fin24
Help us help you by taking our second annual Debt survey and you could win R3 000, or add your voice by sharing your debt experiences, debt-busting tips and insights. Have a question? Ask our experts.
