One of the important decisions faced when selecting a car loan is whether you wish to have a Residual Value or "Balloon Payment" on the loan, and, if so, how large you want it to be. The presence and size of a Residual Value/Balloon Payment affects the amount of your regular monthly repayments as well as the amount owing at the end of the loan.
A Residual Value/Balloon Payment can also be known as an RV, Residual Payment or simply Balloon. Read on to find out what a Residual Value/Balloon Payment is, how it affects your loan, and some of the factors you should consider when choosing a Residual Value/Balloon Payment.
What is a Residual Value/Balloon Payment?
A Residual Value or "Balloon Payment" is a lump sum owed to the financier at the end of a loan term after all regular monthly repayments have been made. This allows a borrower to repay only part of the principal of their loan over its term, reducing their monthly repayments in exchange for owing the financier a lump sum at the end of the loan term.
For example: A new car buyer borrows $40,000 over 5 years and elects to have a $10,000 (25%) Residual Value/Balloon Payment on their loan. Their monthly repayments will be lower than if they had no Residual Value/Balloon Payment, however they will still owe the financier $10,000 at the end of the 5 year loan.
The amount of a Residual Value/Balloon Payment may be represented as an absolute dollar value or a percentage of the borrowed amount. With the exception of leases, having a Residual/Balloon Payment on a car loan is optional.
The benefits of a Residual Value/Balloon Payment
The primary benefit of a Residual Value/Balloon Payment is that it reduces the size of the regular monthly repayments due throughout the term of a car loan.
This in turn can provide a range of additional benefits to the borrower, such as increasing affordability and maximum loan size, assisting with cash flow management, and more closely matching the repayment of the car loan's principal with the vehicle's value over time.
What happens when a Residual Value/Balloon Payment falls due?
Where a borrower has elected to add a Residual Value/Balloon Payment to their car loan, the Residual Value/Balloon Payment must be paid as a single lump sum at the end of the car loan's term.
However, there are generally a few options available when the Residual Value/Balloon Payment on a loan falls due:
- If the borrower wishes to keep their current vehicle they can pay the Residual Value/Balloon Payment and finalise the loan. The Residual Value/Balloon Payment can either be paid in cash, or, subject to approval, the borrower can refinance or "roll over" their Residual Value/Balloon Payment into a new loan (in essence, continuing their current loan to cover the Residual Value/Balloon Payment).
- If the borrower wishes to change cars they can sell their current vehicle and use the sale proceeds to pay the Residual Value/Balloon Payment and finalise their current loan. The borrower can then purchase a replacement vehicle, and, if desired, apply for a new car loan to fund the replacement vehicle's purchase. If the borrower's current vehicle is being traded-in as part of purchasing a replacement vehicle then payment of the Residual Value/Balloon Payment on the current car loan can usually be structured into the change-over process, simplifying the process for the borrower.
Minimum and maximum Residual Value/Balloon Payment guidelines
There are different minimum and maximum Residual Value/Balloon Payment guidelines for leases compared to other car finance options. These guidelines are spelled out below.
stratton has access to some of the most flexible financiers in the country - please speak to one of our expert Finance Consultants for more information about the Residual Value/Balloon Payment options available to you. See Talk to stratton, below, for more information.
LeasesThe Australian Tax Office (ATO) imposes a set of minimum Residual Value/Balloon Payment guidelines which must be adhered to for all leases (including Finance Lease, Novated Lease, Personal Lease and Fully Maintained Novated Lease). The ATO minimums are as follows:
|Lease contract term||Minimum Residual Value|
/ Balloon Payment
The maximum Residual Value/Balloon Payment available for a lease varies depending upon a range of factors specific to each finance company, including the age of the vehicle, the term of the lease, the specific type of lease used, the borrower's financial profile and more.
Other types of car finance
There are no minimum Residual Value/Balloon Payment guidelines for other types of car finance (including Consumer Car Loan, Hire Purchase, Chattel Mortgage and Personal Loan). With these types of car finance adding a Residual Value/Balloon Payment to the loan is entirely optional.
The maximum Residual/Balloon Payment available for non-leases varies depending upon a range of factors specific to each finance company, including the age of the vehicle, the term of the loan, the specific type of finance used, the borrower's financial profile and more.
Residual Values/Balloon Payments and Resale Value
There are a range of factors to consider when choosing a Residual Value/Balloon Payment, but one of the most important is the expected value of your vehicle at the end of the loan term.
Ideally, your Residual Value/Balloon Payment should be less than or equal to the value of the vehicle when the Residual Value/Balloon Payment falls due. By following this rule of thumb, if you wish to change vehicles at the end of your loan you are effectively left with a zero balance from which to start your new loan contract - or better still, a deposit to put towards your next vehicle.
Key to determining a vehicle's resale value at the end of the loan term will be the kilometres travelled. If the estimated travel is more than the approximately 15,000 to 20,000 kilometres travelled by the "average" driver annually, the expected resale value and Residual Value/Balloon Payment may need to be adjusted. The reverse is also true - a vehicle expected to travel less than the average could reasonably be expected to retain a greater percentage of its original value. Read our tips for protecting car resale value for more information.
Regardless of how your Residual Value/Balloon Payment compares with the vehicle's value at the end of your loan term, it's important to note that the Residual Value/Balloon Payment can usually be refinanced (subject to approval) at the end of the original loan contract if you wish to retain the vehicle.