High interest rates drive consumers to balloon payments when buying vehicles
|Published
With many South Africans battling the cost-of-living crisis, it is not surprising to see Standard Bank recording an increase in consumers using balloon payments.
Africa’s biggest lender by assets said it has seen a third of their customers looking to buy a car opting to include the maximum balloon payment in the past 12 months.
New vehicle sales plunged for the eighth consecutive month in March this year, with the main driver being the high interest rates in South Africa.
“Given the current cost-of-living crisis, and the 15-year high interest rates in South Africa, consumers are looking for more ways to stretch their budget. High fuel costs have added to consumer strain by pushing up vehicle ownership costs significantly in the past three years,” the head of Standard Bank Vehicle and Asset Finance (VAF), Glenn Stead said.
Overall, new vehicle purchases including a balloon payment have increased by 41% in the past five years, the bank’s data showed.
Balloon payments can make monthly repayment more affordable, which appeals to people who rely on private transport to get to work or school.
A balloon payment works like a deferred debt that consumers can opt to move to the end of their contract. Monthly instalments are then calculated based on the principal debt minus the deferred debt portion.
Stead said that Standard Bank VAF observed that some consumers don’t fully understand how this type of deal will affect them down the line.
There’s a large sum to pay when it’s due
The consumer will know at the beginning of the contract how much they will need to pay after their last instalment.
When the time comes, they can pay off the balloon in cash or enter into a new agreement to re-spread the payment. This usually requires one to apply a month or two before the last repayment.
Because re-spreading qualifies as a new agreement, consumers can spend an extra 12, 24 or 36 months paying off the balloon amount.
They can only take ownership and get the original eNATIS documents once the full balloon amount is settled.
“That’s why you need to think ahead when choosing to take a balloon payment. However, re-spreading can have its benefit. Consumers can choose to keep their repayments slightly lower than their current instalments,” Stead added.
A balloon can be paid-off or settled with a trade-in
Consumers can make additional non-contractual payments towards their VAF accounts, but they must explicitly request that these payments be used to off-set the balloon amount. Otherwise, the additional amounts would be directed towards the principal debt and have no impact on the balloon payment.
Another option chosen by 96.5% of Standard Bank VAF customers who had a balloon is to trade in their vehicles prior to the balloon maturing, as part of their replacement cycle.
“When this happens, the balloon is settled as part of the trade-in process, thus only 3.5% of our customers have had balloon [payments] that required settling or re-spreading,” Glenn said.
Why a balloon costs more in the longer term?
The total amount the consumer will pay at the end of their financing term will be higher with a balloon payment.
For instance, when a consumer buys a R200 000 vehicle at a 10% interest rate and opts for a 20% balloon, they will pay R10 000 more after six years.
This is because while the consumer pays interest on the principal debt, there are no payments made towards the balloon amount.
Interest is charged from day one on the balloon amount too.
“If you don’t want higher interest to accumulate on your balloon portion, you can make additional ad-hoc payments and ask your lender to allocate those towards the balloon,” Stead added.
Each person’s risk profile determines their balloon percentage
Balloon payments are expressed as a percentage of the vehicle’s total purchase price, excluding additional warranty or service plan costs.
Most banks allow up to a maximum of 40%. Not everyone will qualify for the 40% maximum because the qualification criteria consider the consumer’s overall risk, which is influenced by factors such as age and make and value of the vehicle in relation to the loan amount given. Based on these factors, a bank can approve or decline a balloon payment application.
“In Standard Bank VAF’s case, the only time we can approve a balloon payment over 40% is when the initial financing period is short – 24 months or lower. We also look at the customer’s affordability score and the car being financed. Where the car depreciates far slower than the typical vehicle that we finance, we may approve a balloon payment over 40%” Stead further added.
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