Before deciding which car finance option is best for you, make sure you know what each entails.

By: Athenkosi Sawutana

When you apply for credit to buy the wheels of your choice, financial institutions will give you three options: instalment finance, instalment finance with a balloon payment, lease purchasing, and rental.

Before deciding which option to take, it’s important to understand what each entails.

1. Instalment finance

This is the most popular option. Monthly repayments are calculated on the purchase price of a vehicle, minus the deposit that is put down at the start of the deal. The repayments are calculated over a specific period, and ownership passes to the customer when the vehicle is paid in full.

According to Cyril Zhungu, head of automotive retail at Standard Bank, you can structure the finance period over longer periods of up to 72 months depending on your affordability.

In addition, you are not restricted on how you choose to use the vehicle during such financing period. For instance, other plans restrict drivers in terms of mileage per annum.

With instalment finance, you are responsible for all costs related to the vehicle, including maintenance, unless value-added services are included in the contract.

2. Instalment finance with a balloon payment

This option is similar to instalment finance, except a portion of the purchase price is set aside so that the repayments are calculated on a lower amount. These balloon payments are like deposits, except they’re payable at the end of a term instead of at the beginning.

“You must be cautious of the amount you put into a balloon because you will be responsible for the lump sum once the finance term is finished,” says Wesbank.

While it may be attractive to have lower monthly repayments because of the larger chunk of the purchase price placed in a balloon, the repayment of a balloon can be an unexpected debt. This amount will either need to be settled or refinanced at the end of the deal.

3. Lease purchase

This is where you avail finance to use the vehicle for a specific period for either business or personal purposes, but ownership does not necessarily pass to you at the end of the contract.

Normally lease transactions are structured over shorter periods, where at the end of the period, the vehicle is returned to the financier. However, you have an option to purchase the vehicle at the end of such a contract, but you are not obligated to.

Firstly, you do not need to worry about the replacement risk as the vehicle is handed back to the financier at the end of the contract.

Secondly, a lease purchase affords you the opportunity for any capital claims and expense claims against your tax positions should you use a leased vehicle for business purposes.

With a lease purchase you can drive a new car more frequently with the option of changing to a different finance option with less risk than through an instalment sale.

4. Rental

This is similar to leasing, but no ownership passes to you at the end of the period. The purpose of a rental is for both private individuals or companies who need a vehicle without wanting to buy or own it at the end of the rental period.

Zhungu says rental agreements have similar advantages to that of a lease, but ownership never passes to the customer.

“The advantage of a rental is payment for usage only without any responsibility of replacement risk at the end of the contract period and the customer simply hands back the vehicle at the end of the contract,” he says.

The downside of a rental is that the contract comes with usage restrictions and conditions, including maintenance and mileage covered per annum. This is because the financier carries the residual value risk on such a vehicle at the end of the contract.

Rentals are therefore not suitable for you if you cover long distances or inconsistent distances which may result in penalties when you exceed the stipulated mileage of the contract per annum.

Before purchasing a car, consult an adviser who will explain what you can and cannot afford. Affordability is based on your credit profile or score, and therefore the outcome is different for everyone.

This article has been prepared for information purposes only and it does not constitute legal, financial, or medical advice. The publication, journalist, and companies or individuals providing commentary cannot be held liable in any way. Readers are advised to seek legal, financial, or medical advice where appropriate.