In the world of vehicle finance, there are several ways in which cars can be bought, sold, or traded. In most instances, cars are purchased through the bank by applying for and obtaining a loan.
Depending on the financial situation of the customer and the nature of the transaction, these finance deals and loan agreements may be structured in several ways.
In this piece, we will be taking a closer look at balloon payments as a part of finance agreements. We will unpack what they are and how they are used in the world of vehicle finance. We will also shed some light on the positive and negative aspects of balloon payments.
Some vehicle loan/finance agreements are structured with a balloon payment. From the outset, these can make new vehicle offers seem quite enticing to some consumers. Balloon payments may work for some people, but they can also cause their own challenges for others.
What is a balloon payment?
A balloon payment is essentially a lump sum cash payment that is linked to a vehicle finance loan agreement. This payment is often due closer to the end of the vehicle loan period and is considerably larger than the usual monthly repayments. Balloon payments are usually used to reduce the monthly fixed instalments for the period of the loan agreement. They are generally used by people who have good credit scores and a substantial annual income.
Is a balloon payment a good idea?
Some people agree to balloon payment terms because they believe that by the time the loan period is up they would have had some form of an increase in their income to facilitate the lump sum payment at the end of the finance agreement.
The balloon payment terms only make the monthly repayments more affordable over the loan period and this makes the new vehicle purchase seem like a great idea. The bulk cash balloon payment is then only due in four to five years depending on the loan agreement terms. A lot of people believe that they will have enough time to accumulate the capital to pay off the balloon payment when the loan period is up.
It is important to note that balloon payments aren't more affordable, they just spread the total costs of the vehicle out differently.
If there is no guarantee that your income will increase in time, then you should rather choose a finance option that suits your current financial situation without creating future debt.
What are the benefits of a balloon payment?
When it comes to buying a new car, a balloon payment can be advantageous to people who know their wealth will increase. This allows the buyer to reduce their monthly fees on the new car for the entire period. Reducing the initial monthly payments might also allow some people to buy into a higher vehicle category.
What happens if I don't have the capital to pay off my Balloon Payment?
So you have come to the end of the loan period and you now sit in a situation whereby you now have to pay the balloon payment. If you don't have the capital to do this there are two simple options:
- You may sell or trade-in your car through a dealership and hopefully, you will be able to cover the balloon amount with the money you get from the sale of your car.
- You might have a good credit record from paying the car off and the bank might let you refinance the outstanding amount.
The Pros of Balloon Payments:
- Lower monthly payments
- More affordable short-term capital
The Cons of Balloon Payments:
- Costs of the loan can be higher than normal vehicle finance
- Balloon finance is riskier
If you don't have the money to pay the lump sum at the end of the loan term, there is no guarantee that you will be offered a refinancing option.
At the end of the day, it is up to the buyer to ensure that they are in control of their finances and are well informed about the finance options that are best suited to them.