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Tuesday, 3 October 2017

How To Buy Your Bank A Car

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Zero shirts sold. 
Wait, what?

Why would you want to buy your bank a car, that's just stupid?

You right, it is stupid. Yet millions of South Africans do it! And in fact a lot of people will buy their banks 3 or even 4 cars over their lifetime.

It seems to indicate that despite all the moaning and groaning, South Africans actually love their banks. A lot!

While this may sound ridiculous,  you will soon realise that it is not so far fetched after all. Let's consider a hypothetical South African. We will call him Peter.

Peter starts his working career at age 20, and soon realises he needs a car. Of course since Peter has only just started working, he has no savings to speak of, and so his only real choice is to finance his first car. This is how many people (myself included) start their financial journey, and unless you are fortunate enough to have been given a car by your generous parents, there isn't really any other choice.

Being at the bottom of the career ladder, and the matching pay to go with it, Peter is somewhat conservative with his approach, and he decides to get a R100k car. Nothing fancy, but a decent second hand option. He takes out a loan for 100% of the purchase price, and manages to get finance over 60 months at an above prime rate of 12%.

I am sure you agree, that this is a pretty average purchase - a monthly instalment of R2 224 and some change seems like a reasonable ask.

Time moves on, and Peter diligently makes his monthly payments. After 5 years his car debt has been fully settled. At the end of the 60 months, Peter would have paid a total of R133 467. In other words Peter would have paid around a third of the R100k purchase price over to the bank in the form of interest. While this is of course not ideal, Peter didn't really have a choice and so I think he can be forgiven. The real problem is what most people do after this point. So let's continue.

After the 5 years, Peter has climbed a few rungs up the corporate ladder, and now earns a slightly better paycheck. And of course he now no longer has that pesky car payment to deal with. This is great! He tells himself that he works hard for his money, and he deserves to drive a better car. So he trades in his current car (not worth that much any more after the effects of depreciation) and uses that as a deposit. In a mad stroke of luck and coincidence, Peter finds another car which requires exactly another R100k finance deal over 5 years at 12%.

The finance deal runs it's course, and again, after the 5 years are up, Peter has paid another 1/3 of a car over to his bank in the form of interest. In total, Peter has now bought his bank 2/3 of a car. At this point he has also progressed further up the corporate ladder, earns slightly more, and now of course "deserves" an even better car...

I think you can see the pattern here. After the third iteration of this pretty "normal" behaviour, Peter would have bought his bank a full car. Why thanks Peter, your bank loves you too!

And of course this can continue in this way for many many more cars. I have summarised the outcome below.

Not sure why you would always buy your car in blue...

As you can see, for every three cars financed at 12% over 5 years (such as Peter), you would end up buying your bank a car.

Now how many cars do you think most people finance in their lifetime?
I am willing to guess that in a 60 year period (say from age 20 to age 80) this could easily be 9 cars. And if each of these cars are bought and financed in a similar way to how Peter did it, the bank would end up getting 3 cars!

Now of course you can argue that a person could get better interest rates as they became older and built up a credit record, they may not always upgrade their car, and they might drive their car for longer than 5 years  etc. etc. - but I think you get the point. (On the other side of this coin though, I haven't even considered that some people opt for financial suicide balloon finance1 and end up buying their banks a whole fleet of cars.)

Out of interest (pun intended), I have put together a table which shows how many cars a person would end up buying their bank according to the number of cars they financed over 5 years at the given interest rate.

How many cars would you like to buy your bank?

Even at low interest rates, if you continuously finance your car purchases, you are going to be buying your bank some cars.

10 cars financed at 14% means you give your bank 4 whole cars! How thoughtful of you! Such generosity is seldom seen - even among husbands and wives. This forces me to ask - do South Africans love their banks more than their spouses? It appears that way!

Is There A Better Way?

I am now going to say what everybody already knows, but what few people end up doing.

There is a much better way to this whole car finance thing, and it will leave you hundreds of thousands (if not millions) of rands better off in the long run.
  1. Try pay extra towards any current car debt. The sooner you can settle outstanding car debt, the sooner you can free up the monthly payment (and the extra monthly payment).
  2. A paid off car is not a signal that it is time to buy a new car. In this day and age, with modern manufacturing and quality, chances are that you can easily get 10, 15 and possibly even 20 years of trouble free motoring out of a car. Drive your current car for as long as possible.
  3. And now the key to really getting ahead - once you have the money freed up from (1) and you are still driving your current car from (2), use at least some of the freed up money to save up so you can purchase your next car cash. Once your car is paid off, take that monthly payment and start paying yourself over the the equivalent number of years it took you to pay off your car loan. This will enable you to easily afford not only an equivalent car, but probably an even better car. (Although I strongly suspect that if you get to this point, you won't even want the upgrade!)
Super easy in theory!

In practice?

Well, just take a look at any South African parking lot...



Till next time, Stay Stealthy!
 - ~ - ~

In response to a balloon finance tweet of mine, someone said it should be renamed baboon finance!