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Buyer Beware: Car Dealership Finance and the Inflatable Pitfall

August 23, 2018
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Car dealership finance

What is car dealership finance?

Car dealership finance is a widely known and exemplary component to the car sale industry. For a few dollars a week, a new or used vehicle can be driven out of the car yard with minimal fuss, and all documentation is taken care of by the dealer.

According to the Australian Bureau of Statistics, in the 12 months leading up to November 2017, an astonishing $8.5 billion was lent to Australian car buyers to finance their vehicles. For many, buying a vehicle is one of the biggest purchases of a lifetime and one that should be entered into with careful consideration.

Yet, far too many Australians overlook the inevitable pitfalls commonly associated with dealership finance when seeking a car loan – namely, that it’s often structured primarily to help sell the car with little focus on the customer’s long-term financial objectives.

The Lowdown on Balloon Payments

Balloon payments are commonly affiliated with dealership finance and are essentially a way of structuring the loan so that it’s manageable from a cash flow perspective. Essentially, a balloon is a payment that’s scheduled for the end of the loan period; it can be a minimal amount or up to 40% of the vehicle’s sale value.

Depending on the way the loan is structured, in conjunction with the borrower’s circumstances, dealership finance that incorporates a balloon payment can be either a positive or a negative thing.

In the absence of a holistic approach and a carefully planned loan structure, where people commonly become unstuck is usually at the end of the loan period when they are hit with the final balloon payment.

Having negative equity is one example of where finance with a balloon payment cultivates an unsuccessful outcome. Moreover, with cars depreciating faster than ever before, it’s not uncommon for people’s balloon debt to outweigh the value of the car, resulting in a financial predicament that is far from ideal.

There are other common scenarios whereby car dealership finance can leave a customer in a financial conundrum. One such scenario is in the instance that the vehicle manufacturer reduces the value of a similar new car to one a customer purchased – for example – 12 months prior. If the vehicle was sold new at $30,000 in 2017, but the same car, when new, is now sold at $26,000 in 2018, not only is the 2017 car owner faced with a normal degree of depreciation, but they’d also need to contend with the fact that the vehicle’s market value has dropped significantly, decreasing the likelihood of equity.

Michael Johnston from National Direct Finance comments, “it’s important that people cut through the emotional aspect of buying a car, and step away from it for a moment to really consider the product they are looking to finance the vehicle with”.

Johnston believes, that while finance with the balloon component can work well when planned correctly, the industry at large should avoid a transactional mentality, “the customer’s whole financial situation and lifestyle should be taken into consideration.”

He thinks the impetus is on the business offering the finance products, “there are questions which need to be asked: what are the client’s financial objectives? Will this loan impact future investments? Is this a financially viable move given the customer’s circumstances and cash flow? It’s something we, as financers, try to navigate and advise on accordingly rather than focus on the sole transaction as any debt and line of credit can have future implications.”

What is the Alternative to Dealership Finance?

The alternative to dealership finance is a personal service that enables access to multiple lenders, giving the customer both choice as well as the opportunity to build a relationship with a finance partner. More options and a holistic approach to financing means other future lending possibilities are taken into considering.

Check out our blog on “What is a car loan broker?”

Contrary to car dealership finance, which typically only offers one lender option, pursuing other avenues of lending enables more choice, thus more financial empowerment for the borrower.

Should you require more information on any of these topics, please contact us today to speak with a car loan broker.

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