Make sure you know the ins and outs of balloon payments before settling on your car finance.
When researching car loans, you may come across options that offer a balloon or residual payment at the end of the term. These loans can offer you lower ongoing repayments as they reduce your principal. However, it’s important to understand how balloon payments work, as well as how they’re different to residual payments, before taking on a loan that offers them as a feature.
What’s the difference between a balloon and residual payment?
Both a residual and balloon payment refer to amounts that are left over at the end of a loan term and which need to be paid out at that time. The key difference lies in how these amounts are determined.
A balloon payment is set in an agreement by the borrower and the lender in order to lower the ongoing monthly repayments. Residual value is based on a forecast how much the asset will be worth once the loan term finishes, taking into account depreciation. A balloon payment does not take depreciation into account.
What are the benefits of a balloon payment?
Balloon payments offer a number of advantages, including:
- Reduce your repayments.
This is the main advantage of balloon payments. As the end payment reduces your principal, your repayments will be lowered. This can allow you to finance your car purchase while still keeping your repayments affordable.
- Flexibility of the balloon payment amount.
The amount of the balloon payment is generally flexible, so you can agree on the amount with the lender. A standard balloon payment is a few thousand dollars, but can be more or less depending on the lender.
- Business benefits.
The increased amount of interest payable may have benefits to those borrowing for business purposes. You will be paying less principal and more interest, and as the principal is non-deductible this can work out in your favour.
Key considerations of financing options with balloon payments
Before opting for lower repayments with a balloon payment at the end of your term, ask yourself the following:
- How much additional interest will you be paying? While your repayments are lower, working out how much the lowered repayments are costing you in additional interest over the loan term is an important step. Are the long-term costs worth the short-term savings?
- How will you pay off the balloon payment? Do you have a savings plan to be able to pay off your balloon payment at the end of the loan term? Will you be refinancing, or putting it on a credit card? Do you have an end-goal in mind for how you will manage the payment.
Should you refinance a balloon payment?
Many dealerships make their money by refinancing balloon payments. If you are coming to the end of your loan term and are unable to pay your balloon payment outright, refinancing is an option to consider.
You should consider this as a new credit product and give it the same consideration as you would give before taking on any other loan. Remember that you don’t need to refinance with the same lender, so you should compare your refinancing options before you apply.
Car loans that offer balloon payments can be a good option to consider as they help keep your ongoing repayments low. However, as they leave you with a large payment to deal with at the end of your term, it’s important you understand everything about this financing option before you apply.