What is a balloon payment car loan?

What is a balloon payment car loan? Simply put, it is a loan agreement where a portion of the loan amount, the balloon payment, is paid in full at the end of the loan term. This is to lower your weekly/monthly repayments.

How does a balloon payment work?

Say you want to purchase a car but you’re not a cash buyer, you’ll need a loan of some kind. So, you organise a loan for X number of years (usually up to a maximum seven years for a new car) but the repayments are a tad too steep for you.

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So, you and your lender agree that you’ll have a balloon payment of X amount, which is usually a negotiated percentage of the total loan amount.

With the balloon payment, your ongoing instalment is reduced enough for you to purchase the car. At the end of your loan agreement term, you will have the balloon payment to pay in a lump sum for the loan to be finalised.

Another option is a car lease with balloon payment. If your vehicle is used for business, you can also look at a residual value novated lease, which is still a car loan with balloon payment but it lets you forgo the GST you would normally pay on the purchase and save overall on repayments because you can pay the loan from your pre-tax salary through salary sacrifice (so long as your employer is happy to do so). This can reduce your overall taxable income.

Do you pay interest on a balloon payment?

The usual loan terms indicate that you pay interest on the car finance with balloon payment included.

If your loan’s end is rapidly approaching, you may wonder how to get out of a balloon car payment. The short answer is, you don’t really because the loan must be paid but you can soften the financial burden by a few methods.

With the balloon payment, your ongoing instalment is reduced enough for you to purchase the car.

One, refinancing the car to extend your loan period to give you some breathing space.

Two, trade-in the car for a newer model and use the trade-in value to go towards the balloon payment in a new loan agreement.

Can you pay off a balloon loan early?

This depends entirely on the lender you choose, as the terms and conditions will vary greatly. Some lenders will apply penalty fees if you pay the loan off early, while others won’t.

Some lenders will have a clause stating that it can’t be paid early, as they want the full interest payments. This is where you have to do your research.

So, are balloon payments a good idea?

As with most things, there are advantages and disadvantages. Balloon finance is often a way to get a better car for less up front but you will always have that car loan balloon payment looming on your financial horizon and that can be stressful.

Purchasing a highly-specified model can help when it comes to refinancing/trading-in the car because the vehicle will have better resale value. Which could in turn reduce the sting of your balloon payment.

If you’re wondering if balloon finance is right for you, take a look at your three- or five-year plan because if your budget is tight now, it may be hard to set aside the ‘savings’ you make on the payments to go towards the lump sum at the end.

You could be stung at the end of the loan term by not being able to afford the balloon payment and you may not wish to enter into another loan agreement.

Also, life happens. You may be in a great financial position at the start of your loan term but things could change for you by the end of it.

Balloon finance is often a way to get a better car for less up front but you will always have that car loan balloon payment looming on your financial horizon and that can be stressful.

Illness, kids, employment changes could all leave you feeling like the balloon payment is an albatross around your neck.

Car finance without balloon payment will be more expensive for the repayments but you will pay off the principle quicker and reduce the interest paid over time.

Often, a loan without the balloon payment is more affordable in the long term.

However, the type of loan you require will greatly depend on your personal circumstances. The most important thing to do is research. Look at the terms, fees and reputation of the lender and compare to at least three others.

This material has been prepared for information purposes only. It should not be taken as constituting professional advice and you should consider seeking independent legal, financial, taxation or other advice to check how the information relates to your unique circumstances.