Balloon payment car loans are a type of financial product that includes a large final lump-sum payment at the end of the 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.
In this article, we delve into how these car loans work, the pros and cons associated with them and who this type of finance is best suited for.
So, how does a balloon payment car loan 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 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 (eg. 10-50%), which is why they have the ability to reduce the cost of your monthly 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 are the pros & cons?
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 (without incurring the usual penalties for making an early or late payment on your auto finance agreement that some lenders charge).
In addition to this, 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 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.
The key disadvantage is that the cost of this type of loan in the long-term is higher. 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.
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.
Who is a balloon payment loan best suited for?
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 monthly repayments to give your budget some flexibility. They are generally advantageous for small business owners and sole traders.
It's also suited to borrowers who plan to sell their cars at the end of the loan term and upgrade to a newer model.
Weighing your options
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.
If you have any queries on balloon payments please get in touch today with one of our vehicle finance experts on 1300 755 494, or if you’d like to get started now you can apply online using our simple platform here.