LOUISE FAIRSAVE: A new car means new debt
If it were that financially easy, we would all have brand new cars and change them as soon as they look a little tacky or when a new model arrives.
However, a car represents, more often than not, a significant financial commitment for its owner.
Particularly for the teenagers and the young adults, it makes a lot of sense to carefully consider how you will pay for it and its upkeep before you acquire any vehicle. Youth is not the only giddy-headed stage for would-be car owners, but it is the most popular stage for rash decision-making.
Occasionally, some first-time owners of vehicles over extend themselves in purchasing the vehicle such that there is little or no money left for its comprehensive insurance and its other operating costs.
Possible ways of financing a new vehicle include the bank loan, the credit union loan or a loan through a car dealer or finance company.
Commercial banks will treat such a loan as a personal loan for consumption purposes unless there is some compelling explanation given to the contrary. The loan will be typically established through a promissory note acknowledging the debt and setting out the repayment terms and conditions.
The bank giving the loan will require that its interest in the vehicle be explicitly noted on the insurance policy covering the automobile. This notation ensures that if the insurance company is ever paying the owner for the vehicle, the outstanding amount owing to the bank must be paid first; the owner receives the remainder. The bank’s debt takes priority over the owner’s interest.
Some bank loans are made on an add-on interest basis. For example, if the borrower needs to obtain $30 000 for a three-year period at a 14 per cent interest rate, this is how the monthly payment would be calculated:
Interest for three years would be $30 000 X 0.14 X 3 = $12 600. Principal and interest would be $30 000 + $12 600 = $42 000.
Total number of months over the three years = 12 X 3 = 36. Monthly payment = $42 600 /36 = $1 183.33
The major disadvantage of this repayment method is that the borrower is paying interest on the full amount of the loan for the full three years although the loan is being repaid in the process.
Some banks will therefore provide financing where the interest is computed on the reducing balance of the loan. With this change of approach to the loan, the monthly repayment reduces significantly even if the interest rate remains the same.
A loan for a vehicle negotiated through a credit union is normally a more attractive option than a bank’s offering because: 1. the interest rate is usually lower; 2. the interest is computed on the reducing balance; and 3. the borrower is conceptually borrowing from himself as a credit union member.
If the cost of operating the lending facility by the credit union is significantly less than the income raised from loan interest and other activities, then the credit union member may receive a part-refund of the interest paid for each year.