Despite how it sounds, balloon payments have nothing to do with buying inflatable novelties, and everything to do with car loans and vehicle finance.
This optional extra can help make your car loan repayments more affordable from month to month, though balloon payments may not always save you money in the longer term.
So, what exactly IS a balloon payment?
A balloon payment refers to a one-off lump sum that you agree to pay your lender at the end of your car loan’s term – it swells up much larger than your previous repayments, hence the “balloon”.
Because this payment can account for a significant chunk of your car loan’s balance (the exact percentage will depend on your lender, and the age and type of your vehicle), your remaining car loan repayments can be reduced as a result.
Nick takes out a loan for $30,000 to buy a car, agreeing to a 5-year term. This would normally involve making 60 monthly payments of $500, plus interest charges on the full loan balance.
If Nick agrees to include a final balloon payment of $15,000, or 50% of the balance, in his car loan, his 60 monthly repayments will instead cover the remaining $15,000 owing, and cost just $250 per month, plus interest charges on the full loan balance.
By making your car loan repayments more affordable from month to month, a balloon payment may be able to help you buy a car you may otherwise struggle to afford on your regular monthly household budget.
Balloon payments for businesses
Balloon payments tend to be more commonly found in car loans for business and commercial purposes, whether as a sole trader, small business, or larger company fleet. Reducing the monthly repayments on a car loan can help a business to manage its short-term costs.
What’s more, because balloon payments mean that each car loan repayment consists more of interest charges and less of loan principal, business owners may be able to claim these interest payments as business expenses on their taxes. You should consult a tax accountant or financial adviser to find out if a balloon payment would likely benefit your business.
Is a balloon payment the same as a residual payment?
The terms “residual value” and “residual payment” are often heard in the same conversations as balloon payments. While both refer to paying a lump sum at the end of a car loan to reduce the regular repayments, there are important differences between residual payments and balloon payments.
Residual payments tend to be more common on car leases, rather than loans, and are calculated based on the forecast final value of the vehicle after depreciation. Balloon payments are fixed values or percentages, and are not based on the value of the car.
What to do with the balloon?
It’s important to consider exactly what you’ll do once you reach the end of your loan term and the balloon payment comes due.
Your options may include:
- Paying it – If your budget allows, you may be able to get yourself debt-free in one fell swoop, though balloon payments are often too large to easily pay off in one go.
- Refinancing – To keep your current car, you can take out a new loan with your current lender or a new one, and repay the value of the balloon over the term of the new loan. This may keep your loan repayment relatively affordable, though you’ll likely end up paying more in total interest charges.
- Selling the car – Don’t need the car anymore? Sell it, and use the sale value to repay the balloon. Of course, this does leave you without a car…
- Upgrading to a better car – Combine the previous two options by selling your current vehicle, and using your current equity plus the sale value to refinance your car loan, borrowing the extra money you need to buy a better car. Some borrowers (particularly business borrowers) have been known to refinance car loan after car loan, upgrading their vehicle each time.