One of the more frequent questions posted by readers is whether it makes sense to pay an upfront deposit on a car.
It seems that dealerships are informing customers that it makes sense not to pay the deposit upfront, but rather to make a lump sum payment 24 months into the contract as it has a bigger effect on reducing your monthly repayments.
While this is true, what people are not calculating is the interest you save in the first 24 months if you had paid the deposit on inception.
If you are purchasing a car, you need to be careful of the information provided by the dealership as the dealer may be incentivised to sign up a larger financing deal. Make sure you look at the financing costs over the full period.
Faisal Mkhize, the managing executive of Absa Vehicle and Asset Finance, provided the following car finance figures based on a purchase price of R300 000 with an initial repayment term of 60 months at an interest rate of 12%:
Option 1: No deposit
Your monthly repayment will be R6 673. The total repayment over a 60-month term will amount to R400 399.
Option 2: R100 000 upfront deposit
Your monthly repayment will be reduced to R4 449 and your total repayment over a 60-month term will amount to R266 933. This equates to a R33 466 saving in interest repayments compared with paying no deposit.
Option 3: No upfront deposit and a R100 000 payment in the 24th month
At inception, the monthly repayment will be R6 673 and the total debt repaid by month 24 will be R200 917. A lump sum payment of R100 000 is then made in the 24th month of the contract, reducing the amount owed to R100 917.
You can opt for the monthly repayment to be reduced to R3 351 and the term remains unchanged. The outstanding balance is repaid over the remaining 36 months.
As you can see in this example, the monthly instalment is reduced to R3 351 compared with R4 449 if you paid the deposit upfront. This may seem appealing and may lead you to believe you are saving money, but the total repayment over 60 months will be R280 828 – R13 895 more than if you had paid the deposit upfront.
Even if you had invested the R100 000 in an account that earns 6% interest for the first 24 months, you would only earn about R12 000, which is still not enough to cover the savings if you paid the upfront deposit.
The higher the interest rate on the car finance, the more money you save by making an upfront deposit.
When signing any credit agreement, always look at the total cost, not the monthly instalment.