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How Does a Car Loan Balloon Payment Work?

May 19, 2020 8 minute read
How Does a Car Loan Balloon Payment Work?

Understanding your car finance options: Could balloon payments be your best bet?

If you’re on the hunt for a car loan, you may have come across the option of a balloon payment in your search. Although a car loan balloon payment could make your repayments smaller, it won’t make your loan any less expensive. As a result, it’s essential to make sure you know the benefits and risks before you make a call. Let’s take a look at the key factors to keep in mind when weighing up your options.

On this page:

    What is a car loan balloon payment?

    A car loan balloon payment is when you make a certain amount of small loan payments and finish the loan with one large payment. You might be able to find some car loans that have balloon payments for lowering your initial repayments without extending the loan term. Car loan balloon payments are also common on car leases.

    The difference between residual payments and balloon payments

    When shopping around and comparing loans, you may come across the terms ‘residual payment’ and ‘balloon payment’. Both of these terms refer to making a lump sum payment at the end of the car loan. However, they each serve different purposes. Residual payments are typically used for car leases, not car loans. The size of the payment is calculated on the final value of the car after the lease has been paid.

    Balloon payments, on the other hand, are solely based on a fixed percentage of the borrowed amount and unlike residual payments, they’re not affected by the car worth at the end of the loan term.

    Will car loan balloon payments make my car more affordable?

    It all depends on your personal situation. Although it might seem that balloon payments make your auto loan more affordable, it’s not always the case. Regardless of how low your monthly payments are, you will always have to end up paying a large sum at the end of the loan. Some people might find that the large payment is difficult to make, which is why many people start saving up as soon as their loan starts. Others might opt for a balloon payment knowing that they’re going to have more disposable income in the future.

    If you end up finding that you can’t afford your car loan balloon payment anymore, your second option would be to refinance your current loan. This will result in you lengthening the loan term and potentially increasing the overall cost. Otherwise, if refinancing isn’t an option for you, you may use your car as a collateral asset to help pay off your debt.

    Benefits of a car loan balloon payment

    Although you’ll owe a large amount after making several small repayments, balloon payments have some benefits. Here are the major ones you should consider:

    • Helps to reduce your initial repayments. This is one of the biggest benefits of a balloon payment schedule. Because you’re only paying off the interest, your monthly repayments will remain small. This is more affordable for many people.
    • Give you time to plan and save. Before starting your payments, your lender will make sure you’re aware from the start how much your car loan balloon payment will be. This means you can save up for the large payment as soon as your loan begins. This will help you earn interest on the money you’re borrowing.
    • Balloon payments can be negotiable. You’ll find that car loan balloon payments tend to be flexible and can be set when you negotiate your loan contract. Generally, you’ll notice that a standard balloon payment is a few thousand dollars, but that can be more or less depending on what type of loan you’re taking out.

    For more information on car loan interest rates, visit the Moneysmart website.

    Disadvantages of car loan balloon payments

    Balloon payments aren’t necessarily suited for everyone. Although there are some benefits to taking out a car loan balloon payment,  if you don’t have the money to pay the large lump sum at the end of the loan, you might find yourself in financial trouble. As a result, you should also consider these disadvantages before fully committing to the loan:

    • Could lead you into more debt. If you haven’t been able to save up for your final balloon payment, you could potentially end up refinancing your loan. That will leave you with more debt as well as interest to pay.
    • Risk of repossession. When taking out a car loan balloon payment, you will inevitably have the risk of repossession of your car. If you can’t afford the final large payment and don’t have the best credit score to refinance, then, unfortunately, your car has the potential to be repossessed.
    • It’s more expensive. Although the purpose of balloon payments is making your monthly repayments lower, you’ll essentially be paying off the balance at a slower rate. What this means is that you’ll be making larger interest payments.

    How much will a car loan balloon payment cost?

    There are a range of online repayment calculators that can help you estimate what you’d owe every month. There are also calculators that can help you estimate your final balloon payment. Although ultimately, repayments will differ from lender to lender. If you’re looking at balloon payments, make sure you check with the loan provider to get an exact quote.

    What to consider before getting a balloon payment

    Before getting a car loan balloon payment, you may want to ask yourself these questions:

    • How much additional interest will I end up paying? Although it’s a benefit that your repayments are lower, you’ll still want to work out how much those lowered payments are costing you in additional interest over the entire loan term. The biggest question to ask yourself is whether those long-term costs of repayments and interest work the short-term savings?
    • How much will I end up paying off on the car loan balloon payment? While repaying the small monthly payments, many people will put away a certain amount in their savings account to manage the final large payment.
    • What will my car be worth when it’s all due? Keep in mind that while you’re paying off your car with any form of a loan, the car will depreciate. This means that the car’s value will decrease over time. One thing to keep in mind is if your vehicle’s value ends up being worth more than the loan amount after a certain period, then you might want to consider leasing your car instead of buying it. This way you will be able to return the car instead of paying more than its resale value after it’s depreciated.
    • Have I considered all my other options? Many people consider balloon payments to be a gamble. If the reason you’re taking out a balloon payment is to pay for your dream car, then you might want to consider other options such as going for a less costly alternative while you’re saving up. The risk might not be worth it unless this is the only option you can afford.

    Other factors you might want to weigh up

    There are plenty of factors to consider when taking out any car loan. A big one is the interest rate of the loan. For example, do you plan on getting your loan on a fixed rate or variable rate? Additionally, you might want to consider where you prefer taking out your loan. Do you prefer taking out a loan through a bank or private lender? There are many advantages and disadvantages to both. Ultimately, what’s right for you will depend on your preference and what you believe suits your needs and financial position the best

    What if I can’t make balloon payments?

    If you have your car as security for your loan, then the lender can repossess the vehicle. Otherwise, the lender could also send your repayments to collections.

    Regardless of how it’s dealt with, not paying off your balloon payment will harm your credit score and might make it more difficult for you to access other types of finance in future. Having a poor credit report could also affect future employment opportunities. Make sure you review your credit report to ensure you have the right credit score and there aren’t any mistakes listed.

    Read our guide for checking your credit score online.

    What happens when my loan term is up?

    When your loan term is up, you have to make the balloon payment to your lender. If you find that the payments throughout the loan term have drained you and you weren’t able to save up enough cash to pay off the balloon payment, then you might need to consider selling your car to make up for the debt.

    Selling your car could also be a good option if you’re considering refinancing and buying a new model. However, keep in mind that you should probably plan this ahead before taking out a loan. It’s important to know that the loan would cost less than the resale value of the car. If you’re planning on refinancing and buying a new model, you can estimate how much your car would depreciate in that term.

    Looking for car loans? We could help!

    Jacaranda Finance is an online lender that can help you access car loans from $5,000 to $35,000. We don’t offer balloon payments on our car loans, however, we do offer flexible repayment plans. Our application could take you just a few short minutes to complete and – best of all – it’s free to apply! So, even if you’re not sure whether we could help you, we encourage you to apply. We’ll work hard to find you a finance option, regardless of your situation.

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