Braai-side conversation often turns to a debate about the merits of buying a new car versus an old one, and paying cash versus getting financing. Inevitably, someone will raise the point that “a car is not an asset.” That’s actually wrong. A car is an asset, although a depreciating asset that loses value over time. In most cases, a car is not an investment.
It is an asset you’re spending money on, whether you choose to own it, or just get access through leasing or renting it. If you decide to own it, you can purchase it with cash or through financing. What is true, however, is that a car is more like a living expense than it is like an investment that will grow. But for most people it makes up a significant portion of how they spend their disposable income, and it’s wise to think carefully about how to make that spend work the hardest for you and be in line with your financial and lifestyle goals.
“Think about your car and how you will pay for it in the context of your financial plan,” says Ernest North, co-founder of Naked, the fully digital insurance platform. “This includes how the way you finance your car will impact your budget, lifestyle and long-term wealth.”
North looks at the benefits and drawbacks of the various ways you can pay for your car:
1. Pay cash for your car
The simplest way to buy a car is to pay cash for it if you have the money available in your bank account. You simply EFT the money over to the dealer or the person you’re buying from, and you’re good to go. However, most people can’t afford to pay cash for a car. And some would prefer to get a nicer or newer car than they can afford to purchase outright.
Pros
You’re not paying interest on a depreciating asset.
You don’t need to worry about upcoming balloon payments.
There are no constraints on your use of the car, such as mileage limitations.
You are not tied to a financing period, and not forced to rethink your ownership of that car at a set point in time.
Cons
It limits your choice of vehicle to what you can afford to pay upfront.
Paying cash for your car ties up money you might want to use for other purposes like a deposit for a house (in investment terms, this is called “opportunity cost”, i.e. you’re losing the opportunity to use your money elsewhere).
You probably won’t be able to enjoy that new car smell as often as someone who leases or finances their vehicle.
TIP: If you’re a bit more established, one option you might consider is drawing money from your access bond and then using it to pay cash for the vehicle. Interest rates on home loans are generally far lower than for car loans and you can pay back what you borrowed as and when it suits you. Make sure to do your research or speak to a qualified financial advisor to find out if this could benefit you.
2. Get a car loan
If you can’t afford (or decide not) to pay cash for a car, you could apply for a loan from the bank or car dealer that you pay back over four to five years. Each month, you’ll pay off some of the loan plus interest. The exact monthly repayment will typically go up and down with the interest rate. With a loan, you generally also pay a deposit – the higher the deposit, the less interest you’ll pay over time.
Certain car loans end with a big, one-time payment (called a balloon payment) to settle the loan. A balloon payment option can make your monthly payments more affordable by reducing your repayment on the capital portion of the loan. However, you will still need to pay interest on the full amount you borrow across the course of the loan.
Pros
Makes a car affordable even if you don’t have enough cash on hand.
Allows you to buy a car that is a bit nicer and more reliable if you’re strapped for cash.
You can drive the car as much as you want without worrying about mileage limitations.
Once the loan term is over, the car is yours to sell, keep, or trade in.
Cons
Interest payments mean you’re effectively paying much more for the same car. If you finance a R250,000 car with a 10% deposit over five years at a 13% interest rate, you’ll pay an eye-watering R82,000 in interest over the full term.
If you want the contract to end early, you usually need to pay a penalty.
Be mindful of a balloon payment. If you’ve chosen to go this route – you’ll need to find a substantial chunk of change at the end of the loan period.
TIP: In some cases, vehicle brands offer a “guaranteed future value” that they’ll pay for the car if you no longer want it at the end of the term. But generally, that sum is just enough to cover the balloon payment. So, it’s not going to provide the deposit for your next set of shiny new wheels. There may also be terms and conditions like a mileage limitation and other service, maintenance and care requirements to get a “guaranteed future value”.
3. Lease-to-buy
Many vehicle brands offer leasing deals for new vehicles that enable you to transition into buying the car. Lease-to-buy agreements provide for you to buy the car for a guaranteed future value when the lease period is over, or to start a new financing deal. Generally, you’ll be able to pay a deposit upfront, which reduces your monthly lease payment as well as the future purchase price.
Pros
Monthly payments may be lower than buying a vehicle on conventional finance.
Lease-to-buy options give you access to a car if traditional financing isn’t successful.
This approach might enable you to get a new car every four to five years.
Some deals include servicing and insurance in the monthly cost.
Cons
The contract is subject to mileage limitations and other care requirements. If the car is not in a good condition, you will pay a penalty at the end of the lease period.
There are usually significant penalties for breaking the lease agreement early.
Lease-to-buy agreements are not very flexible and you have to make use of a specific finance provider.
You will usually need to refinance or pay a hefty final balloon payment if you would like to take ownership of the car at the end of the term.
If you always lease your cars, you will never own a vehicle of your own or get a break from paying a large sum of money each month for access to a car.
4. Car subscriptions
Car subscriptions are the new kids on the block, though South Africans don’t have as many options to choose from as consumers in other countries. The idea is that you can ‘subscribe’ for access to a car the same way you pay for Netflix. Planet42 is one example of a company that offers second-hand cars on subscriptions. It’s usually a month-to-month contract and you can return the car at any point after six months, paying only a one-month cancellation fee. There is no fixed term for how long you pay the monthly rental fee. Depending on the provider, the subscription might include one or more of the following: insurance, maintenance, and servicing.
Pros
Offers access to a car if you have a bad (or no) credit record and can’t get financing.
It’s a much more flexible option than traditional financing.
You don’t have to worry about financing or trade-in values.
An all-inclusive monthly fee makes it easy to see what you’re spending on your vehicle.
Cons
The monthly cost may be higher than leasing a car or buying one outright.
Some providers might have a mileage cap.
5. Long-term rental
Long-term rentals are similar to subscriptions, but there is usually a set maximum rental term. Many of the same companies that offer short-term car rentals (like Avis or Europcar) also offer options to rent for more than 30 days at a time at a preferential rate.
Pros
It’s perfect if you only need a car for short-term use. For example, if you’ll be in a different city for three months for work, don’t need a car for six months while you’re seconded overseas, and then want one for a month-long road trip, you can rent a car where and when you need it.
The rental bill stops when you return the car after the agreed rental period.
Cons
Long-term rental is usually the most expensive way to pay for access to a car.
You have less control over the type of car you will drive. A rental agreement is likely to be for a “VW Vivo or similar”.
Mileage restrictions generally apply.
Making your choice
Deciding how to pay for your car comes down to your financial situation and long-term plans. Some of the questions you can ask yourself include:
– Do you qualify for credit to lease or finance a vehicle?
– How often do you want to get a new car?
– How much cash do you have in the bank? Is there a better investment opportunity for it than spending it on buying a car for cash?
– Are you expecting any changes in your financial life, whether that’s the possibility of retrenchment or the possibility of a promotion?
– How emotionally invested are you in the concept of owning a car?
Very importantly, whatever you decide, don’t forget to budget for the full cost of car ownership. In addition to the costs of the car itself, you’ll need to provide for fuel costs, insurance, maintenance and repairs. If you’re financing your car, it’s wise to budget for the interest rates to increase. Also, don’t forget to get insurance for your new wheels. This will protect your investment in your new baby.
About Naked
Naked is South Africa’s first fully digital insurance platform offering comprehensive and instant cover for cars, homes, contents, and standalone items. Naked uses Artificial Intelligence (AI) and automation to create a new type of insurance experience. Built from scratch and free from legacy processes and systems, Naked is pioneering a business model that aims to restore trust in how insurance works. Consumers benefit from lower costs as well as more control of – and convenience in – their insurance experience. They can get a final insurance quote for their home, its contents, their standalone items or their car in less than 90 seconds, and switch or pause their cover, all online, without speaking to a contact centre agent.
Naked Financial Technology (Pty) Ltd is an authorised financial services provider (FSP 48822). Policies are underwritten by The Hollard Insurance Company Limited, a licensed insurer and authorised financial services provider.
For more information on Naked and its award-winning app, visit www.naked.insure.