Residual purchase agreement
Financing your dream car can be a difficult and lengthy process as it normally involves an outlay of a huge amount of money in one transaction. With car prices increasing every year, more prospective buyers are looking towards cheap car finance options such as a residual purchase agreement, to conveniently fund their new vehicle. These agreements are increasingly attractive to buyers who want to change their car regularly as they offer extra flexibility. This guide will explain what these agreements are and why you might want one.
In This Guide:
- What is a residual purchase agreement?
- How much will it cost?
- What are the advantages of a residual purchase agreement?
- Are there any risks involved?
- How can I find the best residual purchase agreement?
What is a residual purchase agreement?
A Residual Purchase Agreement is a loan with a bank or lender which is paid back over a set period in a series of monthly instalments with a final large payment at the end of the agreement. Under these agreements, it is not until the final payment, referred to as a ‘balloon’ payment, is made that you will legally own the vehicle. When the final payment deadline is approaching, the final ‘balloon’ payment can be refinanced to extend the payment period. Under an RPA, if you do not want to make the final payment you can return the car to the bank or lender once all the monthly payments have been made, and you will not need to make any further payments.
How much will it cost?
This might sound a little complicated so far but the easiest way to explain the agreements and how much they cost are to break them down into the three key costs involved.
The Deposit: This will usually be around 10% of the cars price and you have to pay this fee up front. Some agreements may involve a higher deposit but the larger the deposit fee, the less you will have to pay back in total.
The Loan: The amount you borrow as part of the agreement is based on how much the finance company you are borrowing from believes the car is going to lose in value over the duration of your deal, minus the amount you paid for the deposit. Over the course of the agreement, you’ll pay most of this amount back plus interest. Always be sure to check the interest rate on any deal you sign up to. You should also be wary of deals offering 0% interest, the dealers will often be trying to make their losses back from somewhere else in the deal, for example by increasing the balloon payment.
The ‘Balloon Payment’: The balloon payment on the loan allows the borrower to pay a lump sum at the end of the period of the agreement in order to become the owner of the car. The advantage of having this up-front fee at the end of the agreement is that your monthly instalments will be lower, but the disadvantage is you will end up paying a large amount in one go. If you finish paying your monthly instalments and decide you either cannot afford the balloon payment or you no longer want the car, you can then either refinance the amount still owed or sell the car. Another option here is to get a new car. At the end of these agreements the car may be worth more than the cost of the balloon payment. In these circumstances your dealer will offer you the opportunity to trade in that car and use the extra money as part of the deposit on a new RPA. So, if at the end of the agreed five-year period your car is worth R70,000 and the balloon payment is R60,000 you could use that R10, 000 as a deposit in a new deal to finance a new car.
The cost of the balloon payment is calculated according to how much the vehicle will be at the end of the time. So, for example, if a car will be valued at around R60,000 by the end of a five-year agreement, that’s how much must be paid. This sort of agreement may work better for those purchasing a second-hand car, as its value will not depreciate as quickly as a new car.
So, to sum up, when you sign up to a residual purchase agreement, you will pay a deposit immediately, a loan plus interest over an agreed period and then at the end of that period you have the option to purchase the car by making the ‘balloon’ payment, hand the car back to the dealer, or sign up to a RPA for the purchase of a new car.
What are the advantages of a residual purchase agreement?
- There is no initial large outlay required to purchase a new vehicle, allowing you to purchase a larger or more expensive vehicle you may not have the immediate funds for.
- The combination of monthly instalments and a set date for a lump sum payment can help with future financial planning and cash flow management.
- Under an RPA the monthly instalments are usually lower as the largest payment is not payable until the end of the loan period.
- They’re flexible, at the end of the agreement you can either pay to keep the vehicle, return it to the dealer with no further payments or choose to trade in for a newer car.
- If the car value depreciates quicker than the dealership predicts and you find that the car is worth less than the balloon payment, you can just hand the car back to the dealer without making the balloon payment and they will incur the losses instead of you.
Are there any risks involved?
- If you choose to return your vehicle at the end of the agreement period, you will be liable for any damage to the vehicle or ‘excessive mileage’, so always be sure to check the terms and conditions of any agreement in full.
- To sign up to one of these deals you will often need to provide evidence you can afford to make the final payment, so make sure you have some savings to full back on in order to prove you can make that final payment come what may.
- The loan will accrue interest over the course of the agreement, including on the final ‘balloon’ payment.
How can I find the best residual purchase agreement?
Residual purchase agreements can seem complex but hopefully this guide has given you an idea of what to look for. In order to find the best car finance deal for your needs, be sure to use our comparison tool here and make your dream car a reality as soon as possible.