Many business owners and sales people opt for a residual lease or balloon-payment lease when they purchase a new car. This means that they finance 60 percent of the car and pay the remaining 40 percent (these figures are negotiable) at the end of the lease or when they sell it. Although this reduces the monthly payment, it is the most expensive way to finance a vehicle.

The reason it is so expensive is that the 40 percent residual value attracts interest charges over the entire period of the contract and the capital does not decrease when the payments are being made. If the buyer is not in the position to pay off the residual at the end of the contract, they would have to finance the balance for a further period.

In hot water at the end of the lease

Residual leases have become a popular tool for unscrupulous salespeople to sell their wares. They advertise expensive models with low payments in order to lure in customers. A naïve client may not know the ramifications of taking a residual and they may find themselves in hot water at the end of the lease.

This is a particular problem if the car's resale value does not hold up. For example, if the car cost R200 000 and there was a 40 percent residual they would still owe R80 000. If the condition or mileage of the car was such that it was only worth R60 000, they would have to pay in the balance.

If you took a straight four-year lease or an instalment sale on a R200 000 car you would pay R14 000 less in interest charges. Another problem that arises is that it is virtually impossible to settle the contract early because so little of the capital has been paid. So if your circumstances change, you may be stuck with the vehicle for many years.

Remember, car values plummet

It is interesting to note that residual leases were originally designed for the financing of farm equipment. If a farmer needed new machinery, he could get a loan from the bank and pay back the residual after he had sold his crops. It works well in this scenario because income generated from crops usually increases each year. The same is not true for cars, unless you have a rare collectable, it is not going to appreciate.