What Are Balloon Payments on a Car?

For those who are in the position to buy a new car but don’t have cash on hand to pay for it in one lump sum, vehicle finance is an excellent option. But trying to understand all that it entails can be confusing – terms such as residual and balloon payments may be overwhelming you. Let’s break down what these are and discuss what you need to know before blindly signing a finance agreement that may lead to a nasty surprise down the line.

The basics of financing a car

When you apply for vehicle finance, you are committing to pay a certain monthly instalment over a specified period of time before the car officially becomes yours. Finance for a vehicle is useful even if you don’t have a deposit to put down, and can be the answer to having transport without you having cash on hand. The interest rate offered to you in you loan agreement is based on your risk profile, which includes your spending habits and how faithfully you pay existing accounts and loans. For those who are looking for ways to keep their monthly payments low, they may consider agreeing to a residual, or balloon, payment option.

What is a balloon payment?

In order to keep costs low, a balloon payment sets aside a portion of the vehicle’s value with finance applied to the remaining amount – the “residual” or leftover portion that you’ve set aside then has to be paid once you’ve paid up the loan amount. This is called the balloon payment, and it is often a certain percentage of the value of a vehicle (e.g.: R150 000 vehicle, with a 25% balloon payment requires that you finance R112 500, after which a residual amount of R37 500 becomes payable).

What are the benefits of a balloon payment?

Naturally, the most significant advantage is that it lowers the initial cost and the monthly premiums, and is especially helpful if you don’t have a deposit to put down. For some, this gives you the option of financing a more expensive vehicle for a lower amount. The balloon payment may also be considered for refinancing.

What are the negatives of a balloon payment?

Having to find a lump sum (which is often a large chunk of money you wouldn’t otherwise have on it) can be problematic unless you have put aside money for this from the beginning – which begs the question, why not just pay a higher premium for no balloon payment? In some agreements, the balloon payment cannot be refinanced, meaning you have no option but to fork over a large sum of money. This applies even if you sell or write off the vehicle in an accident – you are still liable to pay his amount. While a balloon payment option can be helpful to those who cannot afford high monthly contributions, be sure that you can pay the lump sum at the end of the finance term or that it can be refinanced to make it an affordable option for you.

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