If you’re battling to pay off that new 4×4, you need to understand the implications of debt consolidation, writes David Warneke.
Let’s look at it this way: if you are paying off your home loan at prime less 2% (13,5%) and your 4×4 is at prime plus 2% (17,5%), by simply adding the car debt to your home loan could save a wad of cash over the term of the car loan. Or would it?
First you need to consider if there are any penalty clauses for early settlement of your car finance arrangement. These can significantly detract from the savings to be achieved. If there are none, or the penalties are not severe, this can be an astute decision. If you have not yet bought the car, financing the purchase directly through the bond avoids these charges and also the initiation fees charged by banks. But, there are a number of things to bear in mind.
Discipline
Let’s look at the numbers. If you owe R350 000 on a car at 17,5%, your repayments will be R10 190 a month over 48 months. In addition to the monthly repayments, you will probably be in for a monthly administration or similar fee. If you settle this debt and add R350 000 to your bond at 13,5%, you will be pay only R4 225 a month, a saving of R5 964 a month.
Yet it is not a good idea to finance a short-term asset such as a car over 20 years. Ideally, you want to match the term of the finance to the useful life of the asset. If you do not, eventually you will be left with a clapped-out asset and many years of repayments still to make.
If you are disciplined enough, you can pay more into your bond each month, effectively paying off the debt over 48 months instead of 20 years. Your monthly payment at 13,5% over 48 months will be R9 476 a month, a substantial saving of around R713 a month compared to R10 190. Over 48 months you will have saved R34 237 by consolidating.
Tax
Tax considerations also enter the picture. If you receive a travel allowance for the car and keep a logbook (which is a good tax savings idea), you need to know what your finance charges are if you claim based on actual expenses. The onus is on you, the taxpayer, to prove your expenses. You will therefore need to show what portion of the interest on your bond is attributable to the car.
If you are disciplined and pay off the debt over 48 months, you will not get a correct answer if you do this calculation based on the relative values of your bond and car debt when you first consolidated. For example, if your bond is R500 000 and your car debt is R350 000, then it will not be true that R350 000 (R500 000+R350 000), or 41,18% of your interest, will be attributable to the car, as this assumes that you are financing both assets over the same length of time. You would need to compute the interest attributable to the car portion another way by using, for example, a financial calculator.
The interest attributable to the car portion of the bond would not be affected by private additions or repayments to your bond, for instance if you were to capitalise renovations to the bond or decrease the home loan portion of your bond through an inheritance received.
As a tax strategy it is always best to pay off non-tax-deductible debt (for example, the home loan portion of your bond) before tax-deductible debt (for example, the car portion, if you receive a travel allowance and keep a logbook). So if you receive a windfall, first apply it to non-tax-deductible debt.
Also bear in mind that with travel allowance reductions, finance costs on a car are limited to what they would be on a vehicle with a maximum cost of R360 000 (including VAT). So, if your car cost you R400 000, for tax claim purposes you are limited to what the finance costs would have been on a vehicle with a cost of R360 000.
Debt consolidation is proving to be a popular way of improving cash flow. But check the small print, do the maths and chat to your chartered accountant to ensure you make the right decision.
David Warneke is a tax partner at Cameron & Prentice Chartered Accountants