Have you thought about getting a car loan? Well, let us help to explain what you can expect from a car loan as well as the finer details. This is how car loans work.

How Do Car Loans Work?

Oct 21, 2019
Author: Ean Barnard

South Africa is not exactly renowned for its public transport. And though we are renowned for our taxis, it just isn’t as reliable as we need it to be. You have no other option but to buy a car. But how do you get a car in South Africa if you can’t buy it cash?

Have you thought about getting a car loan? Well, let us help to explain what you can expect from a car loan as well as the finer details. This is how car loans work.

Once you’re done reading the article, you can get some personalised offers for vehicle finance by clicking here.

Understanding all the basics about vehicle finance

Call it vehicle financing or a car loan. Essentially you’ll be taking out a loan to buy a car. Here are the basic building blocks of a car loan explained in simple terms.

The Lender

This is the institution who offers to lend you money so that you can buy a car. Only borrow from an institution that is a registered credit and financial services provider. The National Credit Act protects the credit market in South Africa by regulating lenders with strict rules.

Car Loan Amount

A loan amount is also called a loan principal. This is the amount of credit you request from the lender. The loan amount on certain loans like a home loan can increase when you apply for more credit against your home. But a car loan has a fixed amount. You can’t increase it afterwards to borrow more money.

Admin and Initiation Fees

Most car loans have admin and initiation fees included. Either as a lump sum at the start, or as part of your monthly payment. Beware, unnecessary fees will make your loan expensive.

Interest Rate Options

Fixed interest rate The vehicle finance agreement will have a locked-in interest rate and cannot change during the loan repayment term.

Variable interest rate A variable interest rate will be linked to the national prime rate and can move up and down as the prime rate goes up or down.

Loan Terms/Period

The loan terms are the number of repayments you need to make. It’s calculated over a period of years. But that means you need to make a specific amount of monthly payments to repay the loan. You can either increase or decrease the loan terms. A shorter loan period leads to more expensive monthly payments (because you need to repay the loan in a shorter span of time). A longer loan period leads to cheaper monthly payments (because you have more time to repay the loan).

Loan Deposit

This is an amount of cash you give upfront.

Balloon Payment

Some lenders call it a lump sum and others call it a balloon payment. This is a part of the loan you need to repay in one big payment at the end of the loan. You need to make the payment or else the lender will take back the car. It is possible to take a car loan without a balloon payment.

Capital balance versus contract balance

The capital balance is the amount you borrowed but it excludes the future interest rate you will pay in monthly instalments. It is the amount you will have to pay if you want to settle the contract. The contract balance is the amount you borrowed plus all the interest calculated onto that amount and it is what you will pay in total for the vehicle if you finance it for the full term.

Vehicle Finance is form of secured finanace. What is a Secured Loan?

A secured loan has something of value as security for the loan. A home loan is a secured form of credit. The lender will take back the house if you fail to repay the home loan. A car loan is also a secured loan. Your lender will repossess (take back) the vehicle if you fail to make payment.

But secured loans have an advantage. It usually has cheaper interest rates when compared to unsecured loans of the same amount. A car loan will have a cheaper interest rate when compared to a personal loan of the same amount. Cheaper interest rates lead to cheaper monthly repayments.

How to Improve Your Chances to Get a Car Loan

So you are thinking about buying a car? But you don’t have the money to buy it cash. A car loan is your next best option. Here are a few things you can do to help improve your chances to get a car loan.

Prove Your Income

Steady sources of income help to secure loans. When you buy a car, make sure you have proof of income so the dealer can negotiate deals with the bank.

Improve Your Credit Score

Improving your credit score is something you do one step at a time. Get the full guide by clicking here.

Increase the Loan Terms/Period

You will have to repay more over the lifetime of the loan, but it will lower your monthly payment. A lower monthly payment could help to fit your budget and convince the lender about your ability to repay the loan.

Opt For a Balloon Payment

It’s risky, but it can be helpful to get you going.

Only Buy What You Need

You don’t need a sports car. You most probably only need something to get you to and from work. Get a loan for the car you need. Buying what you need also helps to lower the total amount you request. A lower loan amount increases your chances of success. Plus it’s cheaper to repay.

Once you’re done reading the article, you can get some personalised offers for vehicle finance by clicking here.

Make a better vehicle finance decision with these tips

1. Avoid unnecessary debt when building your personal finance

It's very unlikely for any person at a young age to be able to buy their first car cash. Even if it is possible, buying your car cash means you will be depleting a big chunk of your savings which could have gone into an investment opportunity. Many experts will advise to not lose out on unique investment opportunities by trying to avoid debt that is actually "manageable". It is important to get time on your side for the sake of compound interest. BUT, this does not mean going full out with the vehicle cost you need to finance! Instead of getting the latest and sleekest car, rather choose an affordable option which doesn't break your cash flow. Remember, cash flow = opportunities.

2. Keep cash flow available for costs associated with buying a car

Your vehicle finance agreement is only one part of the total sum when buying a car. For most purchasing agreements, there are costs included like admin fees, vehicle insurance, fuel and car services. It's important to keep all of those in mind when you are budgeting for a car purchase. Once again, it helps to make a more modest decision with your vehicle type so that you have enough cash flow for all the other costs (expected and unexpected).

3. Work the system but don't break your budget system

There is a fine line between making use of things like longer repayment periods and balloon payments and getting greedy. But, don't break your long-term budget or net worth by paying chunks of interest and residual capital amounts on your car which could have been avoided. We know many of us need a set of wheels to make a work opportunity possible, but in the end it is only a method of getting from A to B. Your friends will appreciate it much more if you can join them for weekend adventures, trips, fun evenings, and other events than not being able to afford anything due to your long-term vehicle costs. If they don't, maybe you need new friends ;-) Ultimately, work the system so you can afford a vehicle, but don't get greedy because you want flashy for the sake of public opinion.

4. Make a long-term decision

Your vehicle can either only cater to your needs now or it can cater for the long-term as well. Keep your dreams, vision and 5-year plan in mind when buying a car. A sporty hatchback is a dream for a young employee, but it's not going to support a small family.

5. Car payments require integrity

Reality happens to everyone when it comes to personal finance. But, it doesn't mean you have to lose your character in the process. Sure, we all feel the corporate giants are just trying to take us for a ride and make money off us, but the vehicle finance company still made it possible for you to get a car. So, if you're not going to make a payment on time, give them a call and arrange an alternative date. You will be surprised at how accommodating they can be.

6. Keep your credit history in mind

If reality does end up knocking at your cash flow, remember that every missed payment and "no-show attitude" will reflect as a negative notch on your credit history. And it will stay there for a long time. Prioritise your vehicle payments so that your credit history gets a boost instead of a dunk.

7. Don't stress it so much

In the end, do your research and make a fun decision! We all need to go through a learning curve and there is no use in stressing over it like your world will end if you make the wrong decision. In the long run, a wrong decision will only add to the wisdom you offer others.

Once you’re done reading the article, you can get some personalised offers for vehicle finance by clicking here.

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