A little known fact is that between 2007 and 2011, the number of South Africans opting to buy cars on residual payments decreased the most to just 9.5% in 2011 from a high of 22% in 2007. That was an extraordinary figure, thus we are sure the number is still below the highs of 2007, but possibly above the lows of 2009. The main driver for this downward trend has been the introduction of cheaper, more affordable cars in South Africa.

First thing's first however, I need to answer what a balloon payment is. A balloon payment, which is sometimes called a residual, is an mount that the buyer of the car will pay at the end of his or her repayment term. It is usually a percentage of the overall amount that the car's purchaser will buy the vehicle for.

Suppose the car you want to buy costs R200,000, at an interest rate of 10% per annum. Vehicle finance through the major banks usually requires that you have at least a 10% deposit for the car. This will ultimately mean your loan will cost R180,000 (which is the price of the car less your deposit). Your monthly repayments would be about R3,824 over 60 months. Your total interest paid over that 5 year period would be R49,400, which converts to about 27.5% of the original R180,000.

Now suppose you buy the same car on a residual contract. This would decrease your monthly repayments to about R3566 over 5 years. At the end of that period, you would have paid a total R53,972 in interest, which is about 30%. The difference between 27.5% and 30% doesn't seem much, but remember, with a residual contract, you do not take ownership of the vehicle until you pay the balloon payment – in this case R20,000. Most often, people don't have that lump sum at the end of the 5 years, or whatever the repayment period was. Because of this, it is quite common that they enter into refinancing contracts with their banks. The purpose of the refinancing is to pay the outstanding amount, which also accumulates interest, over the next few years. Because of a residual contract and failure to pay the balloon amount, you might end up repaying your vehicle finance over an extended period of time.

Some industry experts argue that buying a car on residual is better for used cars, because the original owner has already incurred most of the depreciation associated with owning a new motor vehicle. My advice is that buying a car on residual is best left when you know you can make the balloon payment at the end of your term. It's that simple. However, the best advice on financing the car you want to buy should be with your car dealer and the bank.

This article has been written as an expansion on a Fin24 video on residual payments which you can watch below.

I made use of our website's car payment calculator to determine the numbers on this article. Also remember that the interest rate depends on the condition of the car and your credit worthiness as a buyer.

Author: Pierre Theron