Upgrading your old set of wheels is always an exciting thing to do but having a tight budget can sometimes either hinder or slow down your purchasing goal. If you have been in search of financial assistance, I can only assume that you have come across different financial options and different dealers trying to convince you what is best for you hence making you even more confused. In this article, we will be discussing one of the common financial options known as Balloon Payment helping you figure out whether it’s a good option for your current circumstances.
What is a Balloon Payment?
A Balloon Payment is a financial product where one makes a lump sum payment at the end of the loan term to cover the remaining cost of the loan. Therefore, balloon payments allow you to repay only a small part of the principal of your loan during the repayment period, reducing your monthly payments in exchange you end up paying/owing the lender a lump sum at the end of the term. With that being said, you really need to be careful to avoid getting off guard with this payment method as it may cause you serious financial strain if you weren’t prepared. Lenders have the ability to reduce the cost of your monthly repayments because the balloon amount is usually a significant lump (10-50%) of your loan meaning the balloon payment can be worth 40% of the car’s original sale price.
Let’s say you buy a new car and you borrow $50,000 over five years and opt to have a $15,000 (30%) balloon payment on your loan, over the course of the loan term you will pay $35,000 instead of the full $50,000 hence lowering your monthly repayments. However, you still owe the lender $15,000 at the end of the term.
Who is it suited for?
Balloon payments are suited for people who want to purchase a new vehicle or upgrade their existing vehicle, if you are one who is 100% sure you will have the money to pay off the the lump sum when it’s due and if you are looking to lower your monthly repayments to give your budget some flexibility hence maintaining a healthy cash flow. Additionally, if you want to save interest over the life of the loan, intend to sell your car or upgrade it again at the end of the loan term or are expecting a payout or higher income at the end of the loan term then you could consider this option. It’s also advantageous for small business owners and sole traders.
What are the pros and cons?
The pros and cons of this financial solution will be of help when deciding whether it’s the best option for you.
- The main advantage of this financial option is that you get to enjoy reduced monthly repayments that would have been there if you didn’t have a balloon payment. The amount is subtracted from the principal loan amount hence your repayments are lowered as a result. This gives you the chance to keep your repayments affordable.
- You have the option of either selling or trading in your vehicle at the end of the loan term and use the money to pay back the balloon payment. Alternatively, you could take out another loan to cover the cost of your balloon payment. This will extend your repayment period by another 1 to 7 years. To do this though, you will have to re-apply and re-qualify for finance.
- The balloon payment amount is flexible, so you can agree on the amount with the lender. Typically the amount is usually a few thousand dollars but it can be more or less depending on the lender.
- Balloon payments are risky especially if you are unable to come up with the cost of the balloon payment when it’s due.
- If you intend on taking out another loan to repay the balloon payment, there is no guarantee that your loan application will be approved which will end up putting you in a tight spot.
- Your car may depreciate in value over the years meaning the car is no longer worth the value of the balloon payment.
- The cost of the loan will be higher in the long run as you will accrue interest on the payment over the life of the loan.
Can a balloon payment be paid off early?
This will depend on the lender and the loan product. Some lenders will allow you to pay off your balloon payment without charging you a fee while others will. Ensure you consult first with the lender before doing so.
In conclusion, before selecting this option ensure you select a car that you can afford so as to avoid borrowing money that you cannot repay and put some money aside for the payment so as to avoid being caught off guard. Get to read more on what Balloon Mortgages are.