There is a new trend in the car financing sector called car balloon finance. Despite its name, balloon finance has nothing to do with inflatable novelties, and has everything to do with car loans.
This car finance option can make your monthly car loan repayments easy and more affordable. However, it cannot always save you money in the long run.
So, What is a Balloon Payment on Car Finance?
In finance, the term “balloon” refers to a contract in which you make a large, one-time payment at the close of the contract’s term. This means that the periodic installments (usually monthly) are lower compared to traditional financing options.
With balloon finance car loan, you will spend less on a monthly basis, but will be liable for the balance left on the contract at a predetermined time.
Car Balloon Finance Payments are Not Car Leases
Often, you will find consumers comparing balloon payments to car leases. These are two different car financing options.
With a balloon finance car loan, you will own the car at the end of the contract term. With car leasing, on the other hand, you don’t own any equity in the car, and you’ll have to turn it in when the lease period elapses.
The only downside of balloon finance as compared to leasing is the fact that you are taking a loan to actually buy the car. You don’t have the option of taking it back to the dealership if you can’t pay the final balloon payment.
How are Balloon Payments Calculated?
Balloon payments are usually based on guaranteed future values or residual values of a car. This should be agreed at the start of the auto finance agreements. The future value predictions are based on a number of factors including the model, the make, the general condition, and mileage of the car.
The residual value should not be less than the estimated value of the vehicle at the end of the contract period.
Advantages of Car Balloon Financing
Generally, your month-to-month payments will be low in balloon financing, however, the Annual Percentage Rate (APR) may be higher. This gives you the flexibility to easily manage your cash flow through the term of the contract.
Moreover, since you are able to afford the increased loan amount through balloon financing, you can opt for a top-end car instead of a base model.
Remember, balloon auto loans are not actually affordable – they only spread the cost out in a different way than traditional auto financing.
Disadvantages of Balloon Financing
It’s quite intimidating to pay up a large lump sum of money at once. Therefore, only go for this car financing option if you are ready to make the payment at end of the contract term.
In most instances, you have the option of satisfying the lump sum amount by trading in another car. However, you shouldn’t solely rely on this as credit conditions and car resale values may change over time. Also, keep in mind that if the trade-in value of your car is less than the balloon amount, you will have to cater for the difference.
Another major concern about balloon financing is that since you will be paying for the interest monthly, you will likely spend more on the car than its worth.
If you cannot make a balloon payment, refinancing isn’t always the best option. Sometimes, the loan interest rates (and payments) may go up. As a result, you will pay interest twice which is more than the original principal of the balloon financing car.
Lastly, failure to settle your balloon amount could lead to a bad credit score.
Types of Car Balloon Financing
Some common types of car balloon financing include:
- Novated Lease: This contract agreement involves an employee, employer, and a lender. As the employee, you will make monthly installments to your financer from your income before it is taxed. There will be a balloon payment at the end of the agreement term.
- Fully Maintained Lease: This is similar to a novated lease, but it goes further to include expenses that are related to the car’s running cost such as fuel, insurance, registration, and maintenance.
- Chattel Mortgage: This is usually used when buying a vehicle for business. The lender advances the full amount to the customer who then claims complete ownership of the chattel mortgage car after the purchase. The customer will settle the loan in installments with the residual at the end of the tenure.
Car Balloon Finance is a Viable Auto Financing Option
Just like any other financial decision, car balloon financing requires a lot of planning and consideration. It is crucial to research your options and consider your specific situation. Once you are equipped with all the details, you can decide what’s right for you.