What are Balloon payments?

When it comes to car finance there is an add-on that some financiers allow you to apply known as a balloon payment.  It’s a way that the loan is structured to leave an amount at the end of the loan that you payout in one lump sum. 

The example above shows a difference of  $203.13 per month or $12,187.80 over 60 months LESS paid off the loan during the term. 

Real life example

Michael purchased a new Volkswagen Golf for $50,000. He chose this vehicle due to it’s high resale value. He added a balloon to his finance and had $15,000 to pay out at the end of the 5 year term.
The Golf at year 5 was now valued in the second hand market at $23,000. Michael sold the car for $22,000, paid $15,000 to the financier to cover the balloon. Michael was able to keep the $7,000 tax free.

Over the full term, Michael’s total positive cash was $4,187.80.

Why not $7,000.00?
This is due to the higher amount he paid over the full contract comparing to the no balloon example.
$65,710.80 – $62,898.60 = $2,812.20 (difference between total amount paid on a balloon vs non-balloon option.
$7,000.00 ‘profit’ from sale of car – $2,812.20 = $4,187.80

What happens at the end?

In the scenario with the balloon, you would have to pay the financier $15,000 to finalise the finance contract at the 5-year mark.
You can:

• Sell or trade-in the car and pay the balloon payment to the financier keeping or making up the difference between the residual amount and the sale price
• Pay the balloon payment out in cash
• Refinance the balloon payment and keep the car owning it outright

Benefits of a balloon payment

• Quite simply a balloon payment allows you to have smaller repayments during the term of the loan
• Create affordability on a vehicle that you otherwise may not have the repayment capacity for without a balloon payment
• Closely match the repayment of the loan’s principal amount with the actual lowering value of the vehicle over time
• Increase your personal cashflow to allow you to invest in other areas of your life rather than a depreciating asset (car)

Disadvantages of a balloon payment

• The value of the car at the end of the term depending on the vehicle is less than the balloon payment
• The actual cost of the loan over the term is higher
• Less choice in loan terms if you want higher balloon amounts  (balloon payments % are generally lower on a 3-year term vs a 5-year term)
• You don’t plan for the balloon amount and have a bill at the end of the loan you have forgotten about
• Not all lenders offer balloon payments reducing your choice of lender

Other pitfalls

As you can see by the real life example, the choice of car is important at the start. Doing research on vehicle resale values is important. If your car is worth less than your balloon payment, that is; you sell the car for less than your balloon payment, this is known as ‘negative equity’. You may have to roll this into a new loan when you buy another car or come up with the cash.

Who does a balloon payment suit?

There is no one-size fits all approach to balloon payments. A lot of sole traders and small businesses use balloons to improve cash flow. Private purchasers of higher-value cars also use balloons for the same purpose. It is always crucial that you are able to settle the balloon at the end whilst having the benefits of lower repayments over the term.

Final word

Balloon payments do have benefits if used effectively, but each persons circumstances are different.  A broker will be able to provide you with a scenario with and without a balloon so that you can make an informed decision. 

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