Advance payments on car finance do not work the same as on your home loan, so it’s worth understanding how to make the most of it.
Any debt that you pay off sooner than required will save you money on interest. However, you need to understand how advance payments work depending on the type of asset you are financing.
If you plan on making additional payments on your car finance, it is not as simple as deducting those additional payments from the outstanding balance. The way the banks reflect these additional payments can be very confusing and it is not as flexible as a home loan.
Henry Botha of Absa Vehicle and Asset Finance explains that if you pay in extra on your car finance each month, it is allocated to an “advance payment” account and allocated in accordance with the provisions of s126 of the National Credit Act (NCA).
According to the NCA, this payment is first allocated to interest due or unpaid, then to due or unpaid fees or charges, and lastly to reduce the principal debt.
Extra payments into your account each month do not automatically reduce your agreed monthly repayment amount. These payments are, however, applied to reduce your principal debt which in turn reduces the interest charged over the term of the agreement and will net off in your loan being settled in full prior to the expiry of the agreed contract term. That is the theory.
However, operationally, the allocation of additional payments in reducing the principal debt is achieved by accruing interest on the advance payments, at the contractual interest rate applied to the credit agreement. In other words, the advance payment earns the same interest rate that is charged to the principal debt, in order to create an interest offset.
What causes confusion is that these advance payments and the interest accrued are reflected separately on car finance statements and may cause confusion for customers, so it’s always best to contact the bank directly for them to assist with an explanation.
Once the advance payment reaches a sizeable amount, you can contact the bank and ask for a change to the contractual arrangement. You could ask for the advance payment to be capitalised, which reduces the term of the loan, or change your monthly repayment. But you need to contact that bank and make these changes. Changes are not unilaterally applied merely because a loan is paid in advance.
Botha says that on request, Absa will allocate an advance payment to reduce the balloon/residual payment, reducing the last repayment amount under the credit agreement. However, it is important to remember that the balloon/residual payment forms part of the principal debt, so the interest benefit of advance payments will apply equally.
Botha confirmed that as part of Absa’s broader digitisation programme, it is undertaking a project that will significantly improve customer experience and insight into their statements via a self-service option on the banking app. This is expected to launch some time this year.
Financing houses differ in how they handle advance payments, so it is best to check with whoever issued your car finance.
Wesbank communications head Lebogang Gaoaketse says it is not possible to allocate additional payments towards the balloon payment until the installment finance has been settled.
“As the balloon payment is not due until the end of the agreement, any advance payments and any rebate interest will first be allocated towards the reduction of the amounts due and owing before the end of the term of the agreement. Once all such amounts are paid in full, any further advance payments made prior to the end of the term of the agreement, may be allocated towards the balloon amount owing,” says Gaoaketse.
To capitalise or not?
Capitalising your advance payments has both pros and cons.
If you leave the additional payments as an advance payment instead of capitalising them, you will earn the offset interest and still settle your car finance over a shorter period.
Once your advance payment equals your outstanding loan, you can ask the bank to capitalise the payment and settle the loan.
The advantage of keeping it as an advance payment is that if you are unable to meet a repayment one month, you can use the advance payment to meet your installment.
“This benefits the customer in that any future default is delayed until the advanced funds are depleted and the customer will get rebate interest at the same interest rate of the agreement on the advance amount,” explains Gaoaketse.
If you decide to capitalise the advance payment to be capitalised, the monthly instalment is recalculated and reduced over the same period, or you may choose to add an additional sum to your debit order after processing a capital reduction, in order to keep paying the same instalment amount, thereby reducing the period of the loan.
However, once a capital reduction is done it is irreversible and the advance is no longer available. So, you wouldn’t be able to utilise it if you were unable to meet a repayment.
It is important to note that whether you leave the additional funds as an advance payment or capitalise the additional payments, the net effect is the same in terms of interest saved and a shorter repayment period. By leaving it as an advance payment you have more flexibility if you run into financial difficulty.
If you are wanting to make additional payments to your car finance, it is best to discuss this with your bank and not the dealership. Once the deal is done you are now a customer of the bank. The dealer would not be able to assist you.
This article first appeared in City Press.