Balloon payment car loans are a type of financial product that includes a large final lump-sum payment at the end of the loan term. Balloon payments give you the flexibility to make smaller monthly repayments during the life of your loan, but can be dangerous for people who don't plan ahead. They are more commonly used in commercial vehicle loans, but depending on the lender you might be able to access a balloon payment for a consumer loan too.
In this article, we’ll take a look at how these car loans work, the pros and cons associated with them and who this type of finance is best suited for.
The basics of balloon payments
How does the balloon payment work?
A balloon payment car loan is a type of auto loan that includes a one-off lump-sum final payment at the end of your term, usually made in addition to monthly payments. The balloon payment (also known as the 'residual value') amount builds over the period of the loan by diverting a portion of your interest payments into it, so that your monthly payment amount (from a cash perspective) is reduced. The typical balloon amount is usually a significant lump of your loan (ie: 10-50% of the total loan amount), which is why they have the ability to reduce the cost of your monthly loan repayments in such a substantial way.
The payments are lower because you're paying off what's known as equity, the difference between your purchase price and what it might have cost to buy that same car with cash in hand. Your lender will charge an interest rate on this loan based on how much more expensive financing was than if you had bought the vehicle outright with cash.
What is an example of a balloon payment?
The exact amount you’ll be able to borrow as a balloon payment depends on a few factors, including the lender you’ve gone with and the type of car you’re buying. Balloon payments are often approximately 30% of the loan amount (but can be between 10% and 50%) and are to be paid at the end of the loan term. The bigger your balloon payment amount, the less you’ll have to pay in monthly repayments (but the more you’ll probably end up paying overall!).
For example, say you borrowed $30,000 over four years to buy a car and decided to have a 20% balloon payment ($6,000) on your loan. You’ll pay lower monthly repayments than you would without the balloon payment, but at the end of the four-year loan term, you’ll owe your lender $6,000.
To get an idea of how much a loan with a balloon payment could cost you, check out our car loan calculator (we have a bike and caravan loan calculator too!). Our monthly repayment estimates are inclusive of all lender fees and charges, so we’re giving you the most accurate indication of how much you could expect to pay with a balloon payment car loan.
What’s the difference between a balloon payment and a residual payment?
They both work in a similar way in that they require you to make a larger lump sum payment at the end of your car loan, which has the impact of reducing your monthly repayment amount. The main difference is that where balloon payments are normally used for car loans and are set as a percentage or value, residual payments are used for car leases and are calculated based on the estimated value of your vehicle at the end of the lease period.
What are the pros & cons?
Lower monthly repayments
The main advantage of this kind of auto financing arrangement is that you're able to enjoy lower monthly repayments than would otherwise be possible. You’ll be able to make these payments without incurring the usual penalties charged by lenders for making an early or late payment.
By reducing your monthly repayments, you’ll be able to use your savings to invest in your business or put towards household investments.
Can sell or trade-in your vehicle at the end of the term (to repay the balloon)
Another benefit is that at the end of the loan term you can sell or trade-in your vehicle using the money to repay the balloon, with the option to take out a fresh loan for another vehicle. Or if you're strongly attached to your current car, you don't have to sell it to make the payment. Refinancing (organising a new car loan to replace the one you currently hold) allows you to deal with the balloon repayment and keep your car, or you can simply pay cash.
Higher overall cost
The key disadvantage is that the cost of the loan will be higher in the long-term. This is because you will accrue interest on the balloon payment over the life of the loan. This is more expensive compared to the no balloon payment option, where the principal (or total outstanding loan amount) will be reduced faster and therefore the interest paid over the life of the loan will be smaller.
Paying off the final payment can be difficult (if you haven’t budgeted for it)
Additionally, if you don't have considerable savings, paying off the final lump sum (balloon payment) can be difficult and negatively impact your cash flow. Because getting a loan with a balloon payment requires significant planning and budgeting, it may not be suited to all drivers.
Why would you do a balloon payment?
A balloon payment loan is a good choice if you have the money to pay off the car residual value when it comes due and if you are looking to lower your monthly repayments to give your budget a bit of flexibility. They can be a great option for small business owners and sole traders who are looking to free up their current cash flow situation and aren’t deterred by the higher overall cost that comes with a balloon payment.
Balloon payments can also be suited to individuals and businesses who would like to upgrade their vehicle after a few years and aren’t phased by the idea of selling it towards the end of the car loan term to meet their balloon payment.
When considering whether a balloon payment is a good option for you, make sure you weigh up the benefit of making lower monthly payments with the drawback of having a large lump sum payable at the end of the loan.
Read more: How Much Should You Spend On a Car?
What are my options when the balloon payment is due?
At the end of your loan period, your balloon payment will be due - and you have several options:
- Make the final payment. If you have the cash on hand to do so, simply pay back the balloon payment lump sum amount and you’ll have complete ownership of the car.
- Sell the car or trade it in. You’ll normally be able to cover the cost of the balloon payment, then can take out a new loan for a new vehicle.
- Refinance. Depending on which lender you’re with, you might have the option to refinance your balloon payment and pay it off in instalments (instead of as a lump sum). This is a less popular option as it essentially negates the purpose of getting a balloon payment to begin with.
Other finance options
If you’re not sure that a balloon payment is the perfect finance solution for you, there are a wealth of other loan options available. From non-balloon payment secured and unsecured loans to a range of commercial loan options, electric vehicle loans, caravan and camper trailer loans and car leases, if you’re after a competitive rate on a loan that works for you, Driva can help!
Learn more: 6 Of The Best Ways To Finance A Car
Is a balloon payment a good idea?
Consider what kind of monthly payments would best suit your budget, lifestyle, and credit rating before deciding on whether or not a balloon payment car loan is for you. Taking the time to research all of your options and find the best finance product for you is crucial to ensuring that you can afford your loan repayments.
You can also get an idea of what a car loan with a balloon payment could cost you by using our car loan calculator tool. Make sure you confirm rates and balloon payment amounts with the relevant credit provider.
If you have any questions about car loan balloon payments, or the finance process in general, please get in touch today with one of our vehicle finance experts. Give us a call on 1300 755 494, or if you’d like to get started now you can apply online using our simple platform here. You’ll just need to tell us a few details about you and the type of vehicle you’re looking to buy and we’ll be able to give you your personalised quotes in less than one minute. From there, you’ll be able to see all of your best, pre-qualified rates from across our panel of more than 30 lenders.