Car loans are a great way to get behind the wheel of a new vehicle sooner without the major upfront payment. There are a range of loan options available, however one that stands out due to its unique loan structure is a balloon payment.
In this blog, we provide an in-depth overview of balloon payments, how they work and who they are beneficial for.
A balloon payment is a large, one-time payment made at the end of a loan term. Unlike regular loan payments, which are evenly distributed throughout the loan term, a balloon payment defers a significant portion of the loan balance until the end. This structure often results in lower monthly payments during the loan term. Balloon payments are commonly used in both car loans and mortgages, offering a way to make lower payments initially with a larger payment due at the end of the loan period.
In a balloon payment car loan, the borrower makes regular monthly payments for a set period, typically three to five years. These payments are lower than those of a traditional car loan because they do not cover the entire loan amount. Instead, a large portion of the loan, the balloon payment, is due at the end of the term.
Let's consider a car loan of $30,000 with a 5-year term and a balloon payment of $10,000 at an interest rate of 5% per annum.
Year | Monthly Repayment | Principal Paid | Interest Paid | Remaining Balance |
---|---|---|---|---|
1 | $400 | $3600 | $1200 | $26,400 |
2 | $400 | $3600 | $960 | $22,800 |
3 | $400 | $3600 | $720 | $19,200 |
4 | $400 | $3600 | $480 | $15,600 |
5 | $400 | $3600 | $240 | $12,000 |
END | $10,000 | $10,000 | $0 | $0 |
In this example, the borrower makes monthly payments of $400 for five years and then a balloon payment of $10,000 at the end of the term.
Now, let's compare this with a traditional car loan of $30,000 with a 5-year term at the same interest rate of 5% per annum, but without a balloon payment.
Year | Monthly Repayment | Principal Paid | Interest Paid | Remaining Balance |
---|---|---|---|---|
1 | $566.14 | $4,439.68 | $1,354.00 | $25,560.32 |
2 | $566.14 | $4,666.97 | $1,126.71 | $20,893.35 |
3 | $566.14 | $4,905.72 | $887.96 | $15,987.63 |
4 | $566.14 | $5,156.50 | $637.18 | $10,831.13 |
5 | $566.14 | $5,419.99 | $373.69 | $5,411.14 |
END | $566.14 | $5,411.14 | $28.05 | $0 |
In this example, the borrower makes monthly payments of $566.14 for five years, with no balloon payment at the end. The total loan amount is paid off by the end of the term through higher monthly payments.
To better understand the financial impact, let's compare the total payments made in each scenario over the 5-year term.
Balloon Payment Car Loan:
Traditional Car Loan:
Summary:
While the total amount paid is almost the same in both scenarios, the key difference lies in the monthly payment amounts. The balloon payment car loan offers significantly lower monthly payments, making it easier to manage cash flow. However, it requires careful planning to handle the large final payment. In contrast, the traditional car loan spreads the cost evenly across the loan term, with higher monthly payments but no large final payment.
At the end of the loan term, the borrower must make the balloon payment. Failure to do so can result in default, leading to potential repossession of the vehicle. It's crucial to plan ahead and ensure that funds or financing options are available for the balloon payment. Borrowers should start planning for the balloon payment as early as possible, considering savings plans or alternative financing options.
When the balloon payment is due, borrowers have several options:
Balloon payments are beneficial for:
While both balloon payments and residual payments involve a large payment at the end of a term, they differ in their application:
Balloon payments themselves do not directly impact resale value. However, the condition and mileage of the vehicle can affect its market value. It's important to maintain the vehicle to preserve its resale value.
Yes, refinancing is a common option for managing balloon payments. It's advisable to explore refinancing options before the balloon payment is due. Check with various lenders to find the best terms and interest rates for refinancing.
Yes, you can sell your car. The sale proceeds can be used to cover the balloon payment. Ensure that the sale price covers the balloon amount to avoid financial shortfalls.
Trading in your car is an option. The trade-in value can help offset the balloon payment amount. Discuss trade-in options with your dealer to understand how it can affect the final payment.
For businesses, the interest portion of the car loan, including balloon payments, may be tax-deductible. It's best to consult with a tax advisor to understand the specific tax implications and benefits.
Yes, early repayment is usually possible, but it's important to check with your lender for any potential penalties. Early payment can save on interest but may incur early repayment fees.
Extension options depend on the lender's policies. Some lenders may allow an extension, while others may not. Discuss extension options with your lender if you anticipate difficulty in making the balloon payment.
Balloon payment car loans offer an alternative financing solution with lower monthly payments and flexibility, however a larger one-off payment at the end of the loan term.
If you're considering a balloon payment car loan, the team here at Your Advisor Group will provide professional guidance to help you navigate your
car loan options. Contact us today.
Written By Tyler Cornish
Tyler is the principal mortgage broker at Your Advisor Group and has been in the industry for nine years. His experience and knowledge allow YAG’s clients to receive the highest chance of loan approval. Having helped all types of clients from first home buyers to experienced investors, Tyler takes the time to educate all his customers throughout their loan applications.
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