Borrowing money to buy a car can be expensive. Unless you have a perfect credit score, you’d be lucky to secure vehicle finance at the prime lending rate (10.5%).
However, some dealerships charge more than this.
There are two types of interest rates – linked and fixed.
A fixed rate means you will be charged the same agreed-upon rate for the duration of the loan and your monthly instalment will stay the same.
A linked rate means that the rate is linked to the prime lending rate of South Africa, so when this increases, so will your instalment. When it decreases, you’ll pay less.
Wynand van Vuuren, head of claims and legal at King Price, says: “It’s up to you which rate you choose. Going with the fixed option means that there won’t be any surprises.
"Choosing a linked rate gives you the chance to benefit from smaller payments if the interest rate goes down.”
In light of this, it’s understandable how below-prime finance deals can be enticing.
BMW, for example, is offering the BMW 118i with up to prime -3.48% interest, which means you could pay just 7.02% in interest (linked).
According to Edward Makwana, manager: group product communications at BMW SA, buyers qualify by simply going through the standard credit approval process.
“If it is a special campaign we are running and they qualify for credit, they will obtain the rate,” says Makwana.
Too good to be true?
To figure out if the offers are too good to be true, we need to know why some dealers offer this type of deal.
The reality is that new vehicle sales are declining and some dealerships are trying to invigorate the market.
Statistics from the National Association of Automobile Manufacturers of SA show a quarter-on-quarter decline of 12% in the sale of new passenger vehicles and a decline of 9% of new light commercial vehicles from the fourth quarter of 2015 to the same period last year.
Sales are dipping because of an increase in pricing.
According to the latest TransUnion SA Vehicle Pricing Index, the rate of new and used vehicle pricing increased to 9.4% and 3.3% in the fourth quarter of last year, from 4.6% and 1.6% in the same period in 2015.
Meanwhile, average monthly repayments have increased from R4 656 to R4 910 year on year.
This has, according to Derick de Vries, the CEO of Auto Information Solutions at TransUnion, resulted in consumers financing cheaper new vehicles or more expensive used vehicles, and the used-to-new ratio shows that finance houses are financing 2.5 used vehicles for every one new vehicle.
This is probably not what the likes of BMW have in mind.
The below-prime deals are meant to combat this preference in financing used and cheaper vehicles.
But don’t feel sorry for the dealerships by thinking they are losing out – the truth is, these deals are financed using the manufacturer’s rebate.
Below-prime interest rate deals could also be subject to a balloon payment.
This may not always be a good thing.
One commentator, who declined to be named, warns customers to be vigilant and read the terms and conditions of the deal, as well as the sale agreement.
Find out if there are balloon payments (residuals) attached and find out if you are being sold end-of-range models, which depreciate faster than newer models.
In the instance of BMW, the terms on the website state: “Residual may apply subject to deal structure.”
While a residual, which refers to the lump sum you pay at the end of your loan term, does reduce your monthly instalment, you have to ensure that you can afford to pay it when the time comes.
Often, customers simply take out another loan to deal with the residual instead of saving some of their money to pay off the balloon payment.
It’s generally advised to only take on a balloon payment structure if you have the savings to back it up, or the discipline to put money aside for it.
Van Vuuren says: “If you’re worried about the possibility of not making this payment, you can take out insurance against nonpayment, or you can take shortfall insurance cover in case your car is written off or hijacked while you are still liable for the remaining loan amount.”
Ultimately, below-prime deals could work for you if you can afford the balloon payments at the end of the loan term, and if you get the right car for you.
When you’re in the market to buy a new or used car, be ready to negotiate.