Whether you are in the market for your first set of wheels, or upgrading an old faithful, you may be considering a car loan to help make your new vehicle dreams a reality.
Balloon payment car loans are just one of the many car loan alternatives offered by lenders on the market today, aimed at helping you get on the road without spending all your hard-earned cash upfront.
So what exactly does ‘balloon payment’ mean? This guide will answer all the fundamentals of balloon payment car loans and help you determine whether the product is right for you.
What is a balloon payment?
A balloon payment, otherwise known as residual value, is an agreed-upon lump sum paid to your car loan lender at the end of the car loan term.
A balloon payment is usually a percentage of the total loan value that is paid at the end of the loan term, with the goal to make regular payments more affordable each month or fortnight, compared to if repayments were calculated on the full loan amount.
Balloon payments are usually a significant portion of your car loan amount, anywhere from 10% up to 50%, which gives lenders the ability to substantially reduce the amount of your monthly repayments. Lenders will typically allow you to negotiate your balloon payment amount, which alters the percentage of the total loan amount that the balloon payment comprises.
How are balloon payments calculated?
To explain the basics of the calculation of balloon payments, we will use the following scenario.
Let’s say you buy a new car and borrow $40,000 from a lender at a rate of 7.5% interest over four years with a $10,000 (25%) balloon payment on your loan.
You make loan repayments every week after receiving your pay:
|Balloon payment of $10,000 (25%)||No balloon payment|
|Total repayment after 4 years (Repayments + Balloon)||$47,746||$46,328|
|Cost difference||+ $7,746||+ $6,328|
From the above scenario, you can see weekly repayments will be lower with a balloon payment loan.
Although this may be the case, at the end of the four-year term you will still owe the lender the agreed upon balloon payment - in this case $10,000.
What happens when the balloon payment is due?
There are quite a few options available once it comes time to pay your agreed upon balloon payment, including:
If you're keeping your car - If it's too hard to say goodbye and you want to keep the vehicle, you can pay the balloon payment, finalise the loan and keep your car. It can either be paid in cash, or, subject to approval, you may be able to refinance the payment into another loan.
If you're after a new car - If you want to change to a new set of wheels, you can sell your current vehicle and use the sale proceeds to pay back the balloon payment and finalise your loan. You can then purchase a replacement vehicle, and apply for a new loan to fund the purchase of the replacement vehicle.
Benefits of balloon payments
The most significant benefit of balloon payment car loans, is that you’ll pay less on your monthly car loan repayments over the life of the loan.
For everyday Aussies, this can provide increased affordability, without the need to spend a significant portion of cash through an upfront purchase.
Disadvantages of balloon payments
Balloon payment car loans can often make your loan costlier in the long-run. This is because it is designed to blow up like a balloon, increasing the amount of interest you pay over the course of the loan.
Trading off lower weekly repayments for higher interest, means that while you may pay smaller amounts, interest will be charged on a larger amount of money. The same principle applies if the balloon car loan repayments are made fortnightly or monthly.
What should you consider?
When it comes to balloon payment car loans, you should always consider the type of car you intend to purchase, your individual finances including the balloon payment amount you feel most comfortable making at the end of the loan period and whether that loan should be a fixed or variable rate.
What happens if I cannot make the balloon payment?
If circumstances change and you cannot make the balloon payment, refinancing allows you to deal with the balloon repayment and keep your car. Through refinancing, you can pay off your balloon or residual payment over a period of time, rather than in one lump sum.
Are balloon payment car loans a good idea?
Every person and their finances are unique, so what is right for your friends, colleagues and even family members, may not be right for you.
Having a balloon on your car loan will at the end of the day not save you money overall, because you will have to pay a higher amount of interest across the life of the loan. Where the benefit lies that makes balloon payment car loans a good idea, is that they provide greater flexibility with lower monthly repayments.
Can I pay off my balloon payment early?
If you wanted to pay off your car loan sooner using a balloon payment, you could opt for a shorter loan term.
Extra repayments may be the best alternative to paying off your car loan early, with options ranging from increasing the number of monthly repayments to making a lump sum payment whenever you see fit.
It’s important to note some lenders won’t let you make extra repayments, while others have a minimum or maximum extra repayment you can make over a period of time.