Advance payments on car finance can be confusing, as different finance houses may have different ways of treating these advance payments.

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 pay in extra on your car finance each month, it is allocated to an “advance payment” account in accordance with the provisions of s126 of the National Credit Act (NCA).

The way that additional payments help to reduce the principal debt is 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, which creates an interest offset.

Confusing statements

The problem is that these advance payments and the interest accrued are reflected separately on car finance statements, which often causes confusion for customers. 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.

However, if you want to settle your car finance, any settlement amount provided would take into account the advance payments already made.

A practical example

James has been paying in extra to his car finance with Wesbank and wants to use this to pay off his car.

“I see that I owe R8000, but I have R31 000 in advance payments,” he notes. “Why can’t I use this to settle the outstanding balance?”

In James’s case, if he had not been making those advance payments then the outstanding capital amount would be R39 000. That means Wesbank has already taken the advance payments into account when calculating the outstanding balance.

As Wesbank explains, a client has two options with an advance payment. They can instruct the funds to be used to reduce the capital balance and reduce their monthly installment, or they can use the funds to settle the car finance.

James can give an instruction to use the R31 000 towards settling the outstanding balance and then pay in the R8 000 difference based on the settlement amount.

The settlement amount can be confusing as the settlement amount includes the daily interest accrued to the outstanding balance, which means it increases each day. The bank will normally give a settlement figure which would be valid for five days. This figure would be the outstanding balance plus interest accrued from the last debit order until the expiry date of the settlement statement.

For example, if James’s debit order went off on 1 September and he requested a settlement figure on 10 September, the settlement figure would be valid until 15 September and include interest accrued from 1 September to 15 September. If James only paid the settlement on 25 September, further interest would have accrued.

Therefore, James would be able to settle his car payment by instructing the R31 000 advance payment to be used towards the outstanding capital, plus paying R8 000 on the outstanding balance, plus the interest accrued on the R8 000 outstanding balance.

If you are wanting to settle your car finance, it is best to contact your bank and ask for the settlement figure and on what date that would need to be paid.

Explaining the jargon

Contract Balance

This includes the finance charges (interest). When you take up finance, interest is calculated upfront on the principal debt, resulting in the contract balance. If you settle your car finance early, the interest for the remaining term of the contract is written off. In some cases, this may show on the statement as a “rebate”. This is not an actual rand value that will be paid to you, it just reflects the interest that has been written off resulting in a zero balance.

Current Capital Balance

This balance excludes finance charges (interest), but includes any advance payments. In other words, it has taken the advance payment into account.

Current Contract Balance

This is the balance with interest which includes the advance payment

Advance Amount

This amount is paid to the customer account above the required payments. While it may reflect separately, it is already calculated in the current outstanding balance.

This article first appeared in City Press.