There are only two ways to purchase a car. One option is to pay cash and the other is to apply for a loan from a bank or vehicle finance house. If you are looking for a new ride and are thinking about applying for finance, then the rest of this article will try to unpack the basics of vehicle finance.
What is car finance?
Car finance is when you (the buyer) require financial assistance to purchase a car. In your buying process, you apply to lend money from a reputable bank or a financial business that is approved to lend money to private consumers. You sign an agreement with your chosen financial institution whereby they pay the car dealer or seller the total purchase price upfront and you pay a monthly instalment to your financial institution.
How is car finance structured?
As part of the loan application, the lending institution will either approve or disapprove the application based on the credit and risk calculations that are performed for these types of transactions. If approved, the loan agreement will be structured and presented back to the applicant. In this loan agreement, there will be a cost breakdown of what the agreement charges will be, the interest rate charged, and the instalment amount that is due monthly over the loan term period.
What are the types of car finance options?
Financial deals for motor vehicles are structured in several ways and over different periods.
Some key factors will determine how the loan agreement will be structured that needs to be taken into consideration first:
- Are you putting down a deposit? Deposits are great because they immediately reduce the loan amount you will be paying interest on.
- What are your credit records and scores like? Having a good credit score will go a long way in getting you a better offer from the bank. The less risky your profile, the better the chances of a good offer on interest charged and flexibility of the loan term or duration.
- What interest rate is the bank going to offer you? Based on your credit profile and relationship history with the banks, borrowers will get credit offered at a rate either below prime, on prime, or prime plus.
- How long are you looking to loan the money for? The length of the loan period will also make a difference to the final price of the vehicle. Shorter loan periods usually mean paying less for the total loan agreement, but not necessarily less on the monthly instalment.
- Are you taking a Balloon payment option? A balloon payment can reduce the monthly instalment amount that will be paid on a new car. It also means you have to make a large payment at the end of the loan period to finalise the loan term, loan agreement, and finally have the ownership of the vehicle transferred into your personal name.
- Are you buying or leasing the vehicle? There are two common finance offers that are offered by the banks. Buying the car: You pay a set monthly instalment for the duration of the loan agreement term. When the term and total loan agreement is paid in full, the ownership of the vehicle is transferred into your name. Leasing the car: You pay a set monthly instalment for a specified duration. When the duration of the agreement ends, you return the car to either the seller or dealership where you purchased the car, or your financial institution (based on what was set out in your lease agreement).
Once all of these factors are considered, the finance house or lending institution will lend you the money at an agreed interest rate and give you a specific period to pay the money back, with interest and a total cost of the loan agreement.
When do I take ownership of the car if my finance has been approved?
This depends on the finance option you have taken: If you have taken an instalment sale, then the vehicle only becomes yours once you have paid for it in full. So you drive the car while you are paying it off but it still ultimately belongs to the bank until the final payment is made. However, you can take delivery of the vehicle as soon as your lending institution has settled the sale of the car for its specified purchase price.
If you are taking a finance lease then you lease the vehicle from the bank. Once the lease period is up, you can then either choose to take ownership of the vehicle or you can take out a new lease on a different car. You can also take delivery of the vehicle as soon as the lease agreement has been accepted and signed.
Finance agreements are legally binding agreements, so make sure you ask questions
Make sure you are well informed when it comes to borrowing money to buy a car. If a deal seems too good to be true, it probably is. Buying a car should be fun but it can also end up costing you lots of money in the long run because of interest and loan agreement costs. It is advised that you don't overextend yourself and make sure you shop within your budget of monthly instalments, insurance, and over a loan period that makes financial sense to you to own and maintain your vehicle.
Don't be afraid to ask all the necessary financial questions if you choose to finance your car.