When applying for a car loan, you’ll come across the term “balloon payment” while reviewing the loan agreement. Your lender will explain its meaning, for sure. Still, it’s important to understand the term on your own (and how it will affect your loan repayments) before you sign the dotted line.
What’s a balloon payment?
A balloon payment is a lump sum payable to the lender at the end of the loan term. Also called a residual value, a balloon payment is larger or “inflated” compared to the most of your loan repayments, hence the name. It is an optional payment scheme that you can choose to include or exclude in your car loan agreement.
Upon agreeing to its inclusion, you can negotiate with the lender how large the balloon payment is going to be. The amount will be deducted from the principal loan amount and the difference is where your regular monthly repayment will be computed from.
Pros and Cons
A balloon payment will significantly lower the rest of your regular loan repayments. Including it in your car loan terms is particularly wise if you have existing credit to settle, like a home loan or credit card debts. On the other hand, if you have no solid plan to save for the balloon payment at the end of the term, it’s better to exclude this option since it can lead to financial ruin.
Also, a balloon payment will increase your interest throughout the loan term. This means the total amount you’ll be paying for the car loan will be bigger with a balloon payment than without one.
Let’s crunch the numbers. For example, you were approved for a car loan of $30,000 payable in 5 years with 6.97% interest and has a $9,000 (30%) balloon payment. Your monthly repayments will be $485.55. Meanwhile, the same car loan without the balloon payment at the end of the term will result in $611.42 monthly repayments.
With a balloon payment, the total amount that you’ll be paying for the car loan is $38,133. However, without the balloon payment, the total will only be $36,685.2.
What happens at the end of the loan term?
Once the loan term is up, you’ll need to settle the balloon payment to your lender. If you can’t, you can lose your car because you’d have to sell it to make that final payment. With luck, you’ll be able to sell the vehicle for a higher value than the balloon payment amount. Then, you have some cash left to make a down payment for a new car and at the same time, take out a new loan.
The important thing at this point is being able to sell the vehicle first before applying for another car loan. This way, you can apply for a bigger car loan amount, should you happen to sell your car for a price lower than the balloon payment. You’ll be able to augment your cash and pay off the residual value.
Of course, you can always opt to keep your old car instead of buying a new one. In which case, you can pay off the balloon payment by taking out a refinance or personal loan.
Effect on resale value?
As mentioned before, it’s ideal that the resale value of your car is higher or at least equal to the balloon payment. This will ensure that you’ll have enough money to pay off the balloon payment and earn some cash for a new car down payment.
For this to happen, you need to keep your mileage as low as possible by the end of the loan term. An average Australian driver travels around 15,000 to 20,000 kilometres annually. Travelling below this range per year will help your car retain a good resale value that, hopefully, is equal or higher to the balloon payment.
Who will benefit from it?
A balloon payment will be advantageous for borrowers who plan to sell their cars at the end of the loan term and buy a new one. It’s also suitable for small businesses and car traders because the lower monthly repayments will give them better cash flow. The same is true for individuals who have multiple loans or debts at a time.
Talk to Aussie Car Loans
A balloon payment can be very beneficial but can also cost you more money in the long run. Now that you know all the details about it, you can make an informed decision as to whether or not include a balloon payment in your car loan.
But if you want to know which type of car loan repayment scheme is best for you, it’s best to talk to financial experts of Aussie Car Loans. We can help you determine what monthly repayment amount and end-of-term obligation are most suited to your financial profile.
Aussie Car Loans also have access to a wide array of car financing products that offer flexible terms and competitive interest rates. We can help find the right car loan, whether you’re in the market for a new or used car. Get conditionally approved in as little as 3 minutes with our online application.