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Residual Value or a Balloon Payment Explained
●January 15, 2021●5 minute read
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Taking out loans for various reasons is a smart option in around many parts of the globe, including Australia. The decision to get an advance goes with other choices, such as whether to get a residual value or not. Under certain situations, there is provision for borrowers to use a residual repayment option. Those situations majorly concern leasing of vehicles. Usually, the terms residual and balloon occur interchangeably in financial jargon. You may stumble across some of such terms when talking about loans or leases. Residual values and balloon loans are about to get demystified in this article.
What is a residual value?
The residual value of a car is suitable for addressing car leases. The residual value refers to the worth of a leased car after the lease period. We all know that vehicles depreciate by a certain percentage over years of usage. Thus there is inevitable depreciation on the worth of the car would be higher before taking a lease than after. The residual value is in a place to tell us that price difference and what the new figure is. This value plays a vital role in the determination of the monthly payments towards the lease. Car lenders or leasers often determine the exact residual value, but there are specific guidelines put in place by the Australian Taxation Organisation (ATO). These guidelines spell out the least amount the residual value of a car can stand at after each year after the lease expires.
The following are the guidelines put in place by the Australian Taxation Organisation (ATO): For a car lease of 1 year, the minimum residual value will be 65.63% of the original value; for a car lease of 2 years, the minimum residual value will be 56.25% of the actual value; for a car lease of 3 years, the minimum residual value will be 46.88% of the original value; for a car lease of 4 years, the minimum residual value will be 37.5% of the actual value; for a car lease of 5 years, the minimum residual value will be 28.13% of the original value. As is seen from the ATO guidelines, there is a steady and constant decline in the minimum percentage residual value as the years’ increase. The monthly payments towards the lease are lower because of the residual value of the car.
What is a balloon payment?
A balloon payment is useful for both car loans and car leases. It also deals with the idea of “residual”. It is the amount of money which has remained after the majority of the funds or payments are complete. When you take out and loan or a lease, you are required to make regular payments (usually monthly but it subject to the terms of the loan contract). When a balloon payment is involved in the loan, there will also be a specified amount you would need to pay after the loan or lease has expired to retain or acquire full ownership of the vehicle in question. Whenever there’s a balloon payment request at the end of the loan, the regular repayments reduce. Balloon payments and residual values can work hand in hand on the same projects.
Similarities between residual values and balloon payments
Both the residual value and the balloon payment work with specified quantities after the period of an advance. The two terms refer to an amount paid after the extermination of a lease or loan. While balloon payments are predominately applicable when talking about a loan, and residual values when talking about leases, they both specify that their operations occur at the end of the agreeable debt.
They both lessen your monthly payments towards your car. Whenever either of the factors into debts, they have the tender to reduce the amount you pay at regular intervals up until the end. The benefit of this system is that since there is an accumulated sum at the end, it leads to freeing up some of the payment burdens and somewhat compiling them at the end.
Having reduced payments sounds nice but also note that they attract higher interest rates. Though the monthly payments are made cheaper, you often end up spending slightly more on residual and balloon payments car loan than on a regular car loan.
Differences between the residual value and a balloon payment
People usually get confused as to whether there is any difference in the usage of both of these terms. Though they are quite similar, there are slight differences between the two of them. Residual values are more accurate in regards to a lease, rather than a loan. The residual value is also an estimated and approximated value of the depression the car will experience after each year. While the balloon payment is technically usable for both car leases and car loans, it tends to talk more about a loan than a lease. Balloon payments are also not a percentage of depreciation or estimated depreciation. The balloon payment is less of an approximate minimisation and more of just cutting off some repayments and piling them up at the end.
If you have plans to sell the car after the lease for whatever reason, it is a good principle for the balloon payment not to exceed the residual value. In simpler terms, the amount you owe after the loan to be less than the value of the car after the loan. If the value of the vehicle is greater than the balloon payment, you will be at a loss after selling the car because the proceeds from the car will not be enough to cover the balloon payment. You will have to cover the balloon payment will have through some other means.
The market (car market) is unstable and full of fluctuations. It uses many factors such as depreciation and availability of a specific make, model or year. Before applying for a loan in such an unstable world, one must fully understand all terms and conditions and their workings.
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Written by Jacaranda Team