There are different loan structures available. As lenders draft agreements, whether it is a car, personal, or business loan, you will most likely encounter the term “balloon payment” at some point. What is it exactly?
When you get approved for a loan, you will have to make periodic payments. With a balloon payment, your monthly repayments will be reduced to a certain amount throughout the term of the loan. Part of the agreement is to pay a large payment at the end of the loan, which then clears your debt. This is called a balloon payment, which is sometimes known as the residual value.
How Do Balloon Payments Work?
Let us say that you lease a car and then pay the installments, usually every month. When it is time for you to trade in the vehicle, the value of the transaction is equal to the balloon payment that you have to pay. This structure is not limited to cars, and it can be used for a variety of assets.
Balloon payments are easy to understand. With this type of loan, you get to enjoy lower monthly payments. Installment is much more affordable compared to traditional loans, where you usually have to repay the loan amount and the interest at the same time.
Balloon payments are similar to interest-only loans. The difference is that the latter requires repayments of interest over a set period and then the remaining amount thereafter. With balloon loans, you have to make a large payment one time, typically at the end of the loan term.
One thing that you need to remember with a balloon loan is that the amount builds over the life of the loan. That’s because it works by diverting a specific percentage of the loan’s interest into the payment. This can be 30%, 50%, or any rate (depending on the lender) taken off the total loan amount and interest. So, you can see why you have lower monthly repayments, which is especially true if the agreed percentage is substantial.
As always, situations are unique. Often, contractual financing can be incredibly complicated. That’s why it is essential to know how to approach your situation to determine whether or not you should embrace balloon payments. This type of loan may benefit you if the structure fits your finances. However, you should remember that you will have a big payment to make as you approach the end of the term.
Car Loans with Balloon Payments
Owning a car is vital. This purchase may be one of the biggest expenses you will ever make in your life. Your car is your means of transportation for work, school, and leisure. Unfortunately, not everyone can afford to make a one-time payment for the car they want. This is why almost 90% of Aussies choose to apply for a car loan to finance this special purchase.
When taking out a loan to buy a car, you will encounter terms like variable or fixed interest rates. Interest increases the amount you need to pay each month, along with the other costs of the loan. Balloon payments, for some people, make the loan more affordable.
You have a few options in ensuring that balloon payments work for you. Depending on your situation, you can select from the following methods to help you pay off the large balloon payment:
- You can pay for the whole balloon amount, which takes your mind off the loan. Plus, the car is yours to keep!
- You can refinance the loan, specifically the balloon amount. This strategy will help make repayments easier because you can continue paying smaller amounts each month. You get to keep the car, too.
- This third option will depend on the lender. Your lender may allow you to trade in your car, which means that you do not truly own the vehicle. However, it is an excellent way to buy a new car without paying a significant amount. Read this guide to understand more about car trade-ins.
Regardless of the strategy you choose, you need to pay the lump sum at the end of the loan term. Take note of this agreed-upon percentage before signing the loan contract.
Calculating the Car Loan’s Balloon Payment
You have a car loan of $30,000. It has 6% interest. This interest and the principal amount should be repaid for five years. This particular loan has a 30% balloon payment, which is equivalent to $9,000. Taking this example, your monthly payments will be $451. Without a balloon, you will have to pay $579.98. However, you will need to repay the leftover in full at the end of the loan, which is $9,000.
Comparing the total repayment, you will need to pay $36,059.40 after five years versus $34,798.80 for a non-balloon loan. The interest for a balloon loan can amount to over $6,000. Without a balloon, your interest will only be $4,798.80. The cost difference is more than $1,200 for this example.
Despite the added cost, balloon payments can be beneficial for you. Aside from having a lower repayment each month compared to loans with no balloon, you get to enjoy more cash flexibility. If you have other financial responsibilities to take care of and there’s not a lot of money coming in, balloon payments make sense.
Another reason people choose car loans with balloon payments is that they may qualify for a larger loan amount. If the lender allows trade-ins, balloons are a good option. You can use the proceeds to repay the loan amount, including the lump sum at the end of the loan term.
Refinancing Balloon Payments
You can refinance the balloon loan at the end of the term, which lets you pay off the balloon gradually instead of a lump sum. But be smart; taking out a new loan means that you could accrue more interest costs. The longer the term for refinancing your debt, the more interest you rack up.
If the due date of your balloon loan is fast approaching and you still do not have your finances in order, you can choose to refinance it. In general, you cannot get an extension for your balloon payment. However, you can gradually repay it or get a longer-term through refinancing.
As with any finance, there are some pros and cons when dealing with balloon payments. However, if it fits your financial situation and requirements, it is easy to make things work. Before you apply for a balloon payment loan, you should first determine if it is the best option for you. Ask yourself why you need the car loan and figure out your plans at the end of the term.
Loans Unlimited can help you with your decision. Whether you see that a balloon payment fits your financial circumstances or you prefer to make the same payments until the end of the loan term, we have car loan options for you.
We also have a loan calculator on the website that you can use for free. It will help you determine how much you will need to repay each month with a balloon payment. Use the result as a rough estimate whilst considering how much you can realistically afford every month, along with other factors, such as the vehicle cost and car deposit.
Are you ready to start your car-buying journey? Give us a call or fill out our form and provide us with the amount you require. We will be in touch shortly.
