Car loans and credit criteria

Used car loan

Understanding car loans

About 50% of all cars bought in South Africa are financed through the banks via what are called finance houses.

The four leading finance houses are:

* ABSA Vehicle and Asset Finance Division, a division of ABSA Bank.
* NedCredit, a division of NedBank.
* Stannic, a division of Standard Bank.
* WesBank, a division of First Rand Bank.

How do these finance houses work?

How is interest calculated?

The interest rate is calculated by using what is known as "repo rate" - the rate at which the banks borrow money from the Government's Reserve Bank - and adding a percentage.

This added percentage depends on what is known as your "credit worthiness" - whether you are a good or bad risk for the bank.

A good risk will be someone who already has fixed assets, such as a house, and who has a good banking record - in other words, has not had problems with overdrafts or bad debts.

A bad risk is someone who has no assets, or who might have had banking problems.

A "good risk" pays a lower interest rate than a bad risk.

The banks have a measurement which they call "prime rate" which is the interest rate at which they lend to a "good risk". Prime rate is the repo rate with a percentage added by the bank to cover its costs and a margin of profit.

As a rule of thumb, a person who owns a house, has a good banking record and a steady job can get between 1 and 2% lower than prime rate.

You can often negotiate with the finance houses at the time you apply for a loan to get a better rate.

Loan period

The longer the "loan period", the more interest you pay, although in normal circumstances the interest rate will remain the same.

If you repay the loan in less time than initially agreed upon, you will pay less interest.

However, beware. Finance houses often levy a fee or penalty to compensate for additional administration costs.

Residual value

At the end of the finance period, no matter how old a car is, it always has SOME value, especially when the rate of inflation in the country is high.

As a rule of thumb, this is around 40% of the original purchase price after four years (48 months), and this is known as the residual value.

This value is sometimes used to bring down the monthly payments for a vehicle.

The good news is that often the finance house is willing to re-finance the residual so you carry on paying for the car, but at a much lower monthly repayment since the capital amount is now much lower.

What this method means is that you are basically merely paying for the USE of the car, with, perhaps, a small payment at some time that can go towards your next vehicle.

Different types of financial agreement

The most common type of finance agreement is an "installment sale agreement", previously known as "hire purchase".

An instalment sale agreement is a contract of between 6 and 60 months whereby a customer, also known as the "credit receiver" acquires use and ultimately ownership of an asset.

The car remains the property of the finance house until the final instalment payment is made to the finance house, at which point ownership reverts to the credit receiver.

From a tax perspective, SARS allows the business user to depreciate the asset according to an appropriate formula, usually 25% per annum over a four year period.

The business user may recover the full value of VAT paid at the time of purchasing the vehicle provided that it is a commercial vehicle used in the production of income.

Financial lease

A "financial lease agreement" is a contract whereby the customer, also known as the "lessee" acquires use of the asset for the duration of the agreement in return for a monthly rental.

Motor vehicles are usually financed over a period not exceeding 60 months.

At the end of the agreement period, the customer may acquire ownership of the asset, usually in return for the payment of a nominal sum to the finance house (also known as the "lessor").

This is particularly suitable for a vehicle purchased for business use. Subject to approval by the SARS, the customer will be allowed to offset monthly rentals against income. There is no VAT benefit to the business user with this type of agreement. Only the lessor will enjoy a VAT benefit.

Rental agreement

A "rental agreement" is a contract of between six and 60 months whereby a customer acquires the use of the asset in return for a monthly rental.

When the rental period ends the asset is simply handed back to the finance house.

Strictly speaking the customer may never own a rented asset, and SARS will allow the business user to offset monthly rentals against income.

The business user may claim a VAT input credit on each monthly rental, provide that the vehicle is a commercial vehicle used in the production of income.

Full maintenance lease

A "full maintenance lease" agreement is similar to a rental except that all or most of the costs of maintenance of a motor vehicle are included in the monthly lease/rental fee.

This has extra advantages for a business or business user since all running costs, with the exception of fuel, can be factored in so there are no hidden surprises.

A full maintenance lease can personalised to suit each customer's needs.