When researching your options for car finance, you may come across some unfamiliar terminology which can be a little overwhelming to a first-time applicant. One particular term you might see is ‘balloon payment’.

What is a balloon payment?

A balloon payment is a lump sum that you will owe to the lender and is due at the end of the loan term once all the regular monthly repayments are complete. In essence, you are only repaying part of the principal of your loan. This amount left over at the end is your ‘balloon’ amount. This reduces your monthly repayments, though you still will have to pay off your balloon amount once you reach the end of your loan.

Let’s say that you were approved for a $50,000 car loan over 5 years. Over this 5 year period, you can elect to make monthly repayments on $40,000 (plus interest), and reserve the remaining $10,000 as your balloon payment, due at the end of the 5 years.

The advantage of this payment option is you’ll get to lower the regular monthly repayments. With our previous example, the monthly repayments will be based onthe $40,000 figure rather than the $50,000. These smaller monthly payments will help you manage your cash flow better.

For vehicles purchased for business purposes, the reduced monthly repayments can help lower your short-term business expenses. Also, when opting for a balloon payment, your monthly repayments will comprise more of interest costs rather than the loan principal, so you may be able to claim part of your repayments as a business expense when completing your taxes (discuss this with your accountant).

The main thing to remember about having a balloon payment is that this amount will be due at the end of the loan. If not properly planned for, it can really hurt your budget. Although, there are a few other options available to pay off your balloon amount at the end.

Apply for loan refinancing

You can get another loan from the same lender or a new one to refinance the balloon payment. This will enable you to get another term of monthly repayments instead of paying a large lump sum payment. The only set back of refinancing is the additional interest you will have to pay.

Sell the vehicle

Another option is to sell the car, then use the money to pay off the loan. Subsequently, you can use whatever amount of dollars left as a down payment to purchase a new car or just get a new car loan altogether.

Will this affect the resale value of the vehicle?

No, it’s the other way around. The balloon payment is calculated based on the potential resale value of the vehicle by the end of the loan term. They are more or less the same. So, most of the time, all the money earned from reselling the vehicle will just go to the balloon payment.

How do lenders determine the resale value? By estimating the total distance traveled. The Australian annual average distance traveled by drivers is 15,000 to 20,000 kilometres. Multiply that number by the length of the loan (in years) and you have the benchmark for estimation.

If the estimated travel distance is higher than the benchmark, then the resale value and balloon payment is smaller. On the other hand, if the car is estimated to travel less than the benchmark, then the resale value and balloon payment will be larger.

Talk to CarFinance.com.au

Understanding balloon payments is important when applying for a car loan because it will affect the payment structure, your short-term and long-term budget, and your next step when the loan is about to end.

If you’re thinking of applying for a loan anytime soon, a balloon payment can be a great option for the various reasons explained above. Contact our credit representatives today to discuss your choices or for more information about how balloon payments work.