When you’re selecting a car loan, a key consideration 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. If you’re chatting to one of our dedicated consultants about this option, they’ll know what you’re talking about whether you say balloon or residual, but for this article we’re going to call it a balloon payment! The inclusion and size of a balloon payment can affect the amount of your regular monthly repayments as well as the amount owing at the end of the loan.
Read on to learn how it affects your loan, and some of the factors you should consider when choosing a balloon payment.
So, what is it?
A balloon payment is a lump sum owed to the lender at the end of a loan term after all regular monthly repayments have been made. This allows you to repay only part of the principal of your loan over its term, reducing your monthly repayments in exchange for owing the lender a lump sum at the end of the loan term.
For example: let’s say you buy a new car and borrow $40,000 over five years and elect to have a $10,000 (25%) balloon payment on your loan. Your monthly repayments will be lower than if you had no balloon, however you will still owe the lender $10,000 at the end of the five-year term.
The amount can be represented as an absolute dollar value or a percentage of the borrowed amount. Except for leases, having a balloon payment on a loan is optional and one of our consultants can determine if you qualify.
What about the benefits?
The primary benefit is that you’ll pay less on your monthly repayments throughout the lifetime of the loan.
This in turn can provide a range of additional benefits, such as increasing affordability and maximum loan size, assisting with cash flow management, and more closely matching the repayment of the loan's principal with the vehicle's value over time.
What happens at the end of the loan term?
Where you have elected to add a balloon payment to your loan, it must be paid as a single lump sum at the end of the loan's term.
However, there are generally a few options available when the balloon payment loan is due:
- If you want to keep the vehicle you can just pay the balloon payment and finalise the loan. It can either be paid in cash, or, subject to approval, you can refinance or "roll over" your balloon payment into a new loan (essentially, continuing your current loan to cover the balloon).
- If you want to change vehicles you can sell your current vehicle and use the sale proceeds to pay back the balloon payment and finalise your loan. You can then purchase a replacement vehicle, and, if you’d like, apply for a new loan to fund the replacement vehicle's purchase. If you’re trading in your current vehicle as part of buying your new vehicle then paying off the balloon can usually be structured into the change-over process, which will be simpler for you.
Balloon payments and resale value
There are a range of factors to consider when choosing a balloon payment, but one of the most important is the expected value of your vehicle at the end of the loan term.
Ideally, your balloon should be less than or equal to the value of the vehicle when it’s 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 approximate 15,000 to 20,000 kilometres travelled by the "average" driver annually, the expected resale value and 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 balloon payment compares with the vehicle's value at the end of your loan term, it's important to note that the balloon can usually be refinanced (subject to approval) at the end of the original loan contract if you wish to retain the vehicle.
Talk to Stratton
Talk to your dedicated finance consultant to find out more about striking the right balance between your monthly repayments and your end of term obligations. We have access to a wide range of lenders, and some of the most flexible finance products available. We’ll look at your individual financial position and help find an option to suit your requirements.
For help choosing the right balloon payment for you in the current market, and considering your future vehicle needs, call us on 1300 787 288.