What is a balloon payment?
If you want to buy a car, truck or motorbike, but you can’t quite afford the full loan repayments right now, you might want to consider a balloon payment.
What does balloon payment mean?
The term ‘balloon payment’ refers to the inflated payment you’d make at the end of a loan. This inflated payment is larger than the monthly repayments you’ve been making all along.
For example, you could finance a car paying $1,000 a month and have a final balloon payment of more than $10,000
A car loan with a balloon payment lets you make smaller monthly repayments for the life of the loan.
- Standard car loan – pay more per month but less over the life of the loan
- Balloon payment car loan – pay less per month but more over the life of the loan
Try our balloon loan calculator below to see the difference this can make to your repayments.
How does a balloon payment work?
Regular car loans require you to repay a fixed amount per month. This repayment consists of an interest and principal portion. With a balloon payment you’re repaying less principal, which reduces your monthly instalments. But because you’re paying less principal, you’ll pay more interest over the life of the loan.
Lenders or car dealers may offer balloon payments to:
- Reduce the monthly repayments to make a car more affordable
- Reduce the monthly repayments to give you the opportunity you to buy a more expensive car
- Convince you to buy a particular brand
For example, imagine you took out a $35,000 car loan with an interest rate of 5% and a loan term of five years.
Here’s how much you’d pay in three different scenarios – a standard car loan, a car loan with a balloon payment set at 30% and a car loan with a balloon payment set at 50%.
|Repayments||Standard car loan||Balloon payment car loan (30%)||Balloon payment car loan (50%)|
|Balloon payment at end of loan||$0||$10,500||$17,500|
The standard car loan would save you $2,060 over the life of the loan, compared to the 50% balloon car loan.
However, the monthly repayments would be $257 less with the 50% balloon car loan compared to the standard car loan.
In the above example, if you only had $500 per month to spend on a car loan, you might not qualify for a standard car loan and therefore might not be able to buy a car. But by adding in a balloon payment, you might qualify for a car loan and could then buy a car.
Car dealerships may use balloon payments to lock you into their brand. For example, they may offer you finance on an expensive brand with a 40% balloon payment at the end of three years. Their hope would be that the reduced monthly installments would make the expensive car more affordable, so you didn’t buy a cheaper car instead.
Dealerships may also guarantee the balloon payment. For example, they may offer to take the car back when the balloon payment is due. This may be the option dealerships prefer because they can then sell you a new car.
What happens to a balloon payment once the loan term ends?
When the loan term ends, you’re required to make the balloon payment as your final instalment if you want to own the car.
Your contract may also provide for other options, like handing the car back to the lender (or dealership).
What options do I have when a balloon payment is due?
You don’t have many options once the payment is due other than paying it or handing the car back, if applicable. So you should plan for the balloon payment ahead of time.
- Save additional money so you can make the balloon payment
If your financial situation improves after a year or two, you can start saving money so you can make the final balloon payment. But if your savings are not earning at least as much interest as you’re paying on the car loan, this may not be a good option. A better option in this case may be to refinance the car to pay less interest.
- Refinance the car to exclude the balloon payment
If you needed a car for work and couldn’t afford to buy it without a balloon option, you could consider refinancing the car once your financial situation or income improved.
Refinance in this instance means you replace your existing car loan with a new loan that does not have a final balloon payment.
You would need to re-apply for car finance and submit all the documentation again. You might even be required to pay an additional deposit or additional fees.
The longer you wait to refinance, the more difficult it could become. For example, if your loan term is five years with a balloon payment, and you used the car for work, the age and mileage on the car may make refinancing it after five years less attractive to lenders, so they might only refinance it by giving you a higher interest rate.
In contrast, if you refinanced the car within about two years of buying it, you would still be financing a reasonably new car with low mileage and might be able to keep the same terms but only pay a higher monthly instalment to eliminate the final balloon payment.
- Sell the car
If you sell the car before the loan is repaid, you will need to settle the outstanding amount from the proceeds of the sale. The outstanding amount will include the balloon payment.
If you can’t sell the car for enough money to settle the full loan, the lender will usually require you to first settle the shortfall before selling the car (if their loan is secured over the car).
- Hand the car back to the dealer
If you no longer want to keep the car, and your loan agreement provided for it, you can simply hand the car back to the dealer or lender instead of making the final payment. The dealer will effectively buy the car back for an amount equivalent to the balloon payment and your contract ends.
Of course, in this scenario, you will no longer own the car and may need to start repaying a car loan from scratch.
Who benefits from a balloon payment?
Car dealers may benefit by closing a sale they wouldn’t have otherwise made or by upselling you.
You could also benefit by being able to buy a car ahead of schedule.
But keep in mind, financing a car with a balloon payment is more expensive over the life of the loan than financing a car without one.
If you’re financing with a balloon payment to help you manage your cash flow, or because you need a car and can’t afford one otherwise, it may be a viable option.
Balloon payment advantages and disadvantages
The advantages of balloon payments as a method of finance are:
- Reduces your monthly repayments
- Puts less strain on your budget
- Frees up your cash for other investments
- Gives you more time to repay your car loans
The disadvantages of balloon payments are:
- You pay more interest than you would on a standard loan
- You end up with a large final installment
- You could be forced to sell a car you may have wanted to keep
You could also compare financing a car over three years with a large balloon payment to financing a car over seven years without one. Both these methods would cost you more in interest, but may solve the problem of having a large final instalment.
Can you refinance a balloon payment?
Yes, it is possible to refinance your balloon payment – some lenders offer this option.
However, you can’t take refinancing for granted. If you apply for a balloon refinance, lenders will treat this like any other loan application, and use the usual loan assessment criteria.
Want to buy a car but struggling to find one within your budget? A loan with a balloon payment might solve that problem. Click here for a free online quote. If you want help, please fill in this online form or contact National Loans on 1300 947 383 or email firstname.lastname@example.org.