Motor Vehicle Finance

Introduction

Up to 50% of new motor vehicles sold into the South African market are sold for cash. You might find this a bit strange, because don't most of your friends and associates finance their motor car purchases?? This might be the case for the private individual, the small business man, or the car allowance buyer, but when you consider that 85% of new motor vehicles are sold to the corporate market, it begins to make sense. Whilst some corporate entities will raise finance on a per vehicle basis, most large corporate entities arrange a credit line, usually at preferential interest rates, to cater for the acquisition of motor vehicles as well as other fixed assets. This is the 50% of new motor vehicles which are bought for cash.

The major players in the "wheels" finance market in South Africa are:

• WesBank, a division of First Rand Bank

• Stannic, a division of Standard Bank

• Bankfin, a division of ABSA Bank

• NedCredit, a division of NedBank

This list is probably ranked in order of market share at the time of writing. Depending upon which of the commercial banks you presently deal, you might have a particular preference for the financing of your motor vehicle. Be that as it may, there are a number of issues of which you should be aware before committing yourself to, what for many people is, the second largest purchase decision you are likely to make in your lifetime, the largest probably being the purchase of your home.

How do finance houses make money....?

Like any other business, finance houses make money by selling something. That "something" is the use of money. What you pay for the use of money is a thing called interest. The amount of money that you will be paying in interest can be influenced by a number of factors:

• The duration of the finance agreement

• The interest rate charged

• Whether or not the interest rate is linked or fixed

• Whether or not the finance agreement includes a residual value

We'll go into each of these issues in greater detail, but first some information about finance agreements.

Finance Agreement Types

There are three major finance agreement types in common use for the financing of motor vehicles:

Lease Agreement - a contract of between 6 months and ninety-nine years (you've heard of a 99 year lease, haven't you?) whereby the Lessee (you) acquire use of the asset for the duration of the agreement in return for a monthly rental. For practical purposes, motor vehicles are usually financed over a period not exceeding 60 months. At the end the agreement period, you may acquire ownership of the asset, usually in return for the payment of a nominal sum to the Lessor (the finance house). If you purchase the vehicle for business use, this might be the right type of agreement for you. Subject to approval by the SARS, you will be allowed to offset your 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.

Installment Sale Agreement (previously known as Hire Purchase) - a contract of between 6 and 60 months whereby the Credit Receiver (you) acquire ownership and use of the asset in perpetuity. Once you make the final installment payment to the Credit Grantor (the finance house), ownership reverts to the Credit Receiver (you). 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.

Rental Agreement - a contract of between 6 and 60 months whereby you acquire the use of the asset in return for a monthly rental. When the useful life of the asset has ended, you simply hand the asset back to the finance house. Strictly speaking, you may never own a rented asset. 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.

Your auditor is best qualified to help you choose the agreement type that will best suit your needs.

Interest Rates

When most people finance a motor vehicle they tend to be concerned with the size of the monthly repayment only. Usually the conversation goes something like this:

Sales Person: "So, how much do you want to spend?"

You: "Oh, not more than R1800.00 a month."

Sales Person: "Over what period do you want to finance it?"

You: "Four years."

The sales person knows more or less what it will cost per month to finance a given vehicle. Working with the above example, the easiest thing for the sales person to do is increase the interest rate so that your monthly payment is roughly what you expect to spend. "Using up" your monthly payment would make the example look like this:

What's the benefit for the sales person? Higher commission on the sale of the finance for both the dealership and the sales person. What's the benefit for you? Nothing...in fact you're the one who ends up footing the bill!

Rule Number 2 Negotiate the interest rate you will be paying.

Fixed Rate or Linked Rate?

A fixed rate agreement means that you will pay an interest rate which is agreed with the finance house at the time of signing the finance agreement. If the interest rate changes over the period of the agreement, you will continue to pay the fixed rate.

A linked rate agreement means that you will pay an interest rate which is "linked" to the prime interest rate. You will typically be quoted an interest rate of such as "Prime plus 2". If the prime interest rate is currently 15% this will translate into an actual interest rate of 17% at the time of signing the finance agreement. Let's say the prime interest rate increases by 1 % after six months. From that point onwards you will pay an interest rate of 18%. if, on the other hand, the rate drops to 14% you will pay an interest rate of 16%.

So, which do you choose? This is a tough call, as you need to forecast in which direction interest rates are likely to move. One way to decide is to ask the finance house whether it recommends a fixed or a linked interest rate. Chances are the finance house will recommend a fixed rate if it forecasts a drop in interest rates and a linked rate if it forecasts a rise in interest rates. I would be inclined to pick the opposite of what the finance house recommends.

Rule Number 3 Fixed interest rate if rates are likely to rise, linked interest rate if rates are likely to drop

Duration

The duration of the finance agreement influences the amount of money you pay to the finance house in interest. Look at this example:

By shortening the agreement period to 48 months you will save R4 971.30 in finance charges. The sales person will probably try to persuade you to finance the vehicle over the longest period because "the monthly payment is lower". In truth, you do not benefit, the bank does.

Rule Number 4  Pay for the vehicle over the shortest possible period that you can afford.