When is a balloon payment a good idea?
A balloon payment is a large lump sum last repayment at the end of your loan term. Most common with business use loans, but they are available to personal use loans in some cases.
At the end of the loan term, your options to pay the larger balloon amount would be to:-
- Trade the car in and use the proceeds or part of the proceeds to pay off the balloon.
- Refinance the balloon over a new loan term, either with the same financier or a new one.
- Pay the balloon out with a cash lump sum.
Here are some tips on when you might want to think about using a balloon payment.
Tip 1 – To Get The Car You Want To Fit Within Your Budget
A balloon payment will reduce your normal periodic repayments by leaving the last payment a larger amount, usually based off a percentage of the purchase or borrow amount. This can help you get into a more expensive car if you had a set budget in mind, which may just get you the better model you thought you couldn’t afford.
Tip 2 – To Make Your Repayment Have a Larger Proportion Of Interest
When you take out a business car loan, the only part of the actual repayment that is tax deductible is the interest component. As you have the ability to claim the depreciation of the car, the principal component is not tax deductible, as that is payment for the car.
When you take out a balloon payment, this would increase the total amount of interest payable over the full term, but also will increase the amount of interest within each payment. What this means is that more of your outgoing cash flow can be tax deductible when taking out a loan with a balloon payment.
Tip 3 – When You Want To Sell Your Trade In Privately
If you trade your vehicle in at a dealership, you will be selling it to them for wholesale value, which leaves many wanting to sell their trade in privately to maximise the sale price.
The unfortunate part about this situation is that when you take your car loan out, you are required to borrow the full amount, because you havent yet sold your car and don't have the proceeds on hand. Once you do sell your car, you could make a lump sum payment on your loan, but your repayments won’t reduce, but only the length of your loan.
A solution to this is to opt for a balloon payment of simmilar size to your current cars value. This will enable you to get a repayment that's lower, rather than just a shorter loan. Once you sell your car, you can pay off the balloon and continue with your car loan as if you never had a balloon on your loan.
Make sure you check with your financier if they will allow the repayment of the balloon at any point during your loan, rather than just at the end of your loan.
Some lenders won't allow you to repay your balloon until it is due, and any additional repayments you make before that time reduce the financied principle rather than the balloon amount.
Tip 4 – Lower Your Repayments And Make Additional Repayments
A balloon payment may also work in your favour if you are in the situation you may receive periodic additional income, not in line with your loan repayments, such as quarterly or annual bonuses.
By taking the balloon payment option, if your lender works in this way, you can reduce your normal payment and effectively make additional repayments towards the balloon. If you do not exceed the balloon amount and still keep the loan for the full term, could mean your additional repayments did not result in paying your loan out early and avoiding early termination fees.
Tip 5 – Easy Upgrade
A lot of people use the balloon payment as a way of keeping their repayments lower and adjusting the balloon amount to the forecasted depreciated value of the car at the end of the term.
When they trade their car in, the balloon payment is made, and they then borrow 100% of their next car with the option of the balloon payment again.
This way they have had use of the car for the full term at the reduced periodic payment and upgraded their vehicle when the balloon was due. This is a popular option for drivers that change vehicles every few years, rather than purchase a vehicle to keep long term.