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.
Interest offset
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.
hi Maya
looking at buying a car at the moment rather urgently. In several months i will free up quite a bit of cash that will allow me to settle the vehicle loan. I want to understand if I do this how the bank will calculate the settlement value., Is it the value at that point in time which I understand to include interest OR will they recalculate and remove any front loaded interest that was added at the initiation of the deal?
You only have to pay the settlement amount at that time. A bank can only charge interest for the period that the loan was utilised. The quote you receive is only to illustrate the total interest that would be payable over the full period.
Hi Maya I have a car loan balance is R131000 and statement is about R19000. Can one negotiate a a lower satlement with cash can bank allow me to negotiate to cut a few thousand?
You can always ask – they can decide
Hi Maya,
I hope you are well.
I’ve been told that making higher payments towards car finance will not make a difference because I’ll still be liable to pay the initial interest amount agreed upon. Is this true?
I am interested to know who told you that. It is not correct. The original contract with the interest to be paid is simply a quote that the bank is required to provide. Who is the finance with?
What is the interest earned on advanced payment if it is not capitlised and left to grow?
In terms of car finance, you earn the same interest on an advance payment as on the debt – so it offsets each other. For example, if you had car finance of R200 000 at 12% interest, if you paid in R50 000 in advance, you would only pay interest on R150 000
Hello Maya, I’m financed by MFC and I’m struggling to pay my monthly installments now due to the increasing interest rate. I used to pay R3400 monthly, now I’m paying R4200 it’s a huge adjustment for me and I’m financially strained.
Should I hand over the car to MFC or continue paying it. I tried making agreements with them but the said the is nothing they can do. I really need the car though.. My balance is R230 000 with a Ballon of R107 000
With the rate hike today that car has become a lot more expensive. You need to make some tough decisions, the worst thing you can do is default
I would like to purchase a vehicle and had a R70 000 deposit. I want my new vehicle financed with no deposit and a balloon payment in place.
Should I use the R70 000 as a deposit upon purchase or do the purchase with no deposit and rather pay the R70 000 towards the settlement of the vehicle _ i want my premiums dropped so what option do you advise for this?
It makes no sense to take a balloon payment! That costs you money. The best thing to do is put down the deposit as that reduces your monthly installment. Please do not believe any dealer who tells you a deposit is a bad thing. They try encourage maximum financing to earn a higher commission
I am thinking about resigning in December and settle the vehicle finance balance I have with ABSA, as well as the baloon payment of R50 000. Will the settlement reduce my balance?
I am not sure what you mean by the settlement reducing the balance? The balance of what?
Be extremely careful of using retirement funds to settle lifestyle assets. There will come a day when you want to retire and you will have no money. There are also significant taxes on withdrawing from your retirement fund
Hi Maya
Can I ask my sister to take a car finance for me,. Then 6 months later she transfers it to my name
What will the implications be
Why would you not take the car finance yourself from the beginning? I would not recommend this because it can affect family relationships. What would happen if you were unable to afford the repayment? How would that affect your relationship with your sister?
I have a car loan with MFC. The repayment is spilt between the principal and the interest amount as per the statement i receive. Is it possible for me to settle the interest amount of the loan with a once off payment? And if its possible, is it wise to do so?
The interest is calculated on the current outstanding capital amount. You cannot pay off future interest. What you can do is settle a portion of the capital and then the interest charged decreases
I requested a settlement amount from mfc, which I received. The settlment amount was paid in full but they are still keeping the interest on the account. In their document, they included daily interest and documentation fees. What is your advise, please.
Johan.behre
each bank has a different set of rules around settlements – best to speak directly to MFC to understand what the issue is
@Maya Fisher-french
So if one is paying extra. Is it not wise to notify the bank to direct the payment or one can just pay and leave it as an advanced?
Thanks
It actually doesn’t make much difference either way – you still get the interest rate saving. The only benefit of leaving it as an advance is if something happened and you missed a payment – they could take that from the advance
please can I have some of your helpful advice 🙂
I have one more year left on the payment of my car which should be done by next year Feb, i have a balloon payment of R78 000 at the end of it.
I have some money from my last car being sold, do you advise me to pay off the balloon payment now? would it help in anyway?
Yes, any debt you pay off earlier reduces the amount of interest you pay. Just make sure you have some other savings put aside for emergencies – do not deplete all your savings so that you have to rely on debt if you have a short-term crisis
Hi Maya,
I have a balloon amount of R88 000.00. and advance amount of R38 000.
Capital owed is R138 000.00 and current settlement is R121 000.00.
I have in personal investment account R90 000.00.
When I look advance amount and investment amount, I would be able to settle the account if the two were not in different account. How can I resolve this? What route should i take to settle my account?
Best to contact the bank or whoever you did the car finance with. They all have different ways of how they allocate the additional capital
I have just settled my car with mfc through trade in and I see a sum of R35000 as rebate, how does this rebate thing work? To whom does it go?
When the account is settled and closed, the rebate amount is the interest amount for the remaining term that Nedbank writes off.
Since there was an early settlement paid, the remaining interest for the term gets written off and would display as rebate on the account, and will result in a zero balance.
Hi,
I have Advance amount on my Westbank Statement and keep increasing monthly obviously I’m paying little bit more than my monthly agreed amount.
So what is Advanced amount?
Frm : Israel
that is the amount you have paid over and above the amount you owed each month up until that point. It has the benefit of reducing your outstanding balance and therefore the total interest you would pay
Maya..I have paid off my Vehicle last month and now my Advance Amount is Negatively. I did not use it to settle my dept rather keep it increasing monthly
So is the Advance Amount payable to me because have decided to keep it increasing.
From:- Israel
Which bank are you with?
HI Maya,
I think Israel is with Wesbank as am I. When settling my account with Wesbank earlier this year there was an Advance/Arrear Amount of R-1243.44, which they did not consider instead i had to pay in around R600. To my knowledge this was the accumulated rebate interest over the contract duration, which is technically my money.
When I requested further information this was the feedback: “We would like to clarify the advance amount (or amount due) as shown on your account after account closure. When an account is closed the financial closure entry will show the Outstanding Contract Balance amount being credited to the account (as it is no longer due to the Bank). The Capital Balance may still show a credit balance however, bear in mind that a settlement will include further daily interest which was never added to the account since the last instalment due date.
We confirm that the settlement quoted was paid therefore no amount is due to be refunded.”
Is this practice of withholding rebate interest by wesbank correct?
I will get more details but it may be that the settlement amount showed was on a specific date. By the time it was closed additional interest was due. For example, if your normal installment was R5000 a month, halfway through the month you would owe R2500 on a pro-rata basis – so that would be added to the final amount owed.
Still have a balance on vehicle 15 years after purchase .vehicle taken by bank after engine ceased . What to do ?
you would need to come to an agreement with the bank on how to meet the shortfall. The debt remains as a negative listing on your credit record so you need to decide if you want to clear it by settling the debt.
This was a very insightful read.
Thank you for taking time to explain this in a very clear way of all the possibilities.
Do you maybe know how to calculate the premium after you decided to capitalize the advance money?
Equation would be
(Amount you owe – advance amount )/ monthly term = new premium
I know the interest must be taken into account but it’s a small factor which anyone who wants to can take it into account themselves.
Amortization does apply, but ask the bank – they may be able to give you an accurate figure
I have just settled my car with mfc through trade in and I see a sum of R35000 as rebate, how does this rebate thing work? To whom does it go?
When the account is settled and closed, the rebate amount is the interest amount for the remaining term that Nedbank writes off.
Since there was an early settlement paid, the remaining interest for the term gets written off and would display as rebate on the account, and will result in a zero balance.
Thanks for this. I have always approached any deal with balloon payments as a no-go but now I understand that I have the flexibility to manage this and relieve the the pressure throughout the life of the deal
Thank you for the clarity, I have been looking such kind of an explanation. The separate advanced amount earning rebate interest was confusing. But now I can see the benefits of keeping it as advanced, earning some interest while paying another at the rate higher that the one offered by savings vehicles is not bad at all.
This is really informative. I understand it better now.
Would rather save it somewhere and pay lumpsum settlement value.
Either way, the key is to be making provision for that balloon payment!
I recently bought the car and it financed by MFC. Can I put more money to reduce my monthly installment. I realised that my monthly installment is too high and there is some cash I got from my previous car which was written off
Yes you can, but you must inform MFC that you would like the additional funds to be used to reduce the installment