Instalment sale, balloon payment or guaranteed future value, what is the difference?

Vehicle financing options have expanded drastically in the last ten years, so it is important to be able to distinguish between the available options in order to ensure that you choose the arrangement that best suits your financial situation.

Buying a car is a significant financial undertaking and having the cash to buy a car is a slim reality in South Africa. Fortunately banks and financial institutions offer various financing options to help South Africans drive the car that matches their wants and needs as well as their budget. Vehicle financing options have expanded drastically in the last ten years, so it is important to be able to distinguish between the available options in order to ensure that you choose the arrangement that best suits your financial situation.

Instalment sale

The instalment sale is the original no-frills option to vehicle financing where motorists borrow the full amount for the car from a financial institution and pay it back with interest in monthly instalments over an agreed time period. Once the last payment has been made the motorist becomes the legal owner of the vehicle. This option is straightforward and allows motorists to gain full ownership, which is great if they plan to keep the car for a long time and build equity in it.

Instalment sale with a balloon payment

An instalment sale with a balloon payment allows for lower monthly payments upfront, which assists with affordability in the short term.

This arrangement sees a portion of the cars price, known as the balloon or residual amount deferred to the end of the finance term. The monthly instalments are then calculated on a smaller amount, making them lower and more affordable across the initial loan period. When the initial loan term ends, the motorist will still need to pay the remaining amount, either as a once off payment from their savings or via a refinancing agreement. Alternatively the car can be traded in and the proceeds from the sale used to settle the balloon payment.

The advantages of this option include lower monthly payments, but the downside is that motorists will still have to deal with the balloon payment at the end of the initial contract period. Motorists are advised to plan accordingly around this.

Guaranteed Future Value

One of the new financing options available to South African motorists is the Guaranteed Future Value option or GFV.

A GFV protects motorists from the eventuality of vehicle depreciation to a certain degree. Vehicle depreciation is the value lost the moment a new car is driven off the showroom floor and continues throughout a vehicle’s lifespan at 10 -15% per year.

With a GFV the dealership guarantees what the car will be worth at the end of the finance contract. Motorists then only need to finance the difference between the purchase price, and this guaranteed future value, plus interest. The result is significantly lower monthly instalments compared to a traditional instalment sale.

At the end of the finance contract motorists will have a variety of options. The car can be traded in for a brand new one, using the guaranteed value to settle the old finance amount. If the car is worth more than the GFV, the motorist gets to keep the difference.

Motorists can keep the car by paying the guaranteed future value amount by way of a new finance agreement and taking full ownership once that is settled.

Alternatively, the car can be returned no strings attached, provided that the motorist has kept to the agreed mileage limits and kept the car in a good condition.

Do the research

Motorists should remember that the monthly payment is only one cost related to vehicle ownership and that they will still need to budget for running costs including insurance, fuel, maintenance and licensing. All these factors should form part of the affordability calculation.

Before one signs on the dotted line for your dream wheels it is important to do your homework in order to determine which financing option is best for you, both over the short and the long term. Compare interest rates, repayment terms and always read the fine print in order to make sure that you understand the total cost of the loan, including any fees.

Motus Select offers innovative tools that allows motorists to calculate how much a car will cost to finance with various permutations of different deposit sizes and balloon payment percentages. View the finance calculator here. In addition, the informative affordability calculator will allow motorists to determine what they can really afford.