Know the facts about balloon payments

1.  What is a balloon payment?

It is often advertised on television or included when buying a vehicle, that a balloon payment is applicable on vehicle financing.  One can easily be persuaded to take a balloon payment, when looking at the reduced monthly instalments which allows one to buy a more expensive car.

It is therefore very important that you understand what you are signing for, and the financial implications of your decision to take a balloon payment.  Know the facts to make an informed decision before signing the paperwork.

A balloon payment can therefore be defined as reducing the monthly instalments, by having a lump sum excluded from loan repayments and to be paid as a whole at the end of the financing term.

2.  How does a balloon payment work?

Including a balloon payment in vehicle financing, means that the vehicle buyer is required to pay a lump sum at the end of the vehicle loan.  The lump sum is a predetermined percentage of the purchase price, plus interest.

Often it is advertised that these lump sums can range on average from 35% to 38% of the purchase price.   The percentage interest paid over and above the percentage of the purchase price, is determined by the financer.

Let’s look at an example:

A car dealership sells two vehicles for R400 000 each, at 10% interest and to be paid of over a 5 year period.  Tshepo’s vehicle is financed with a balloon payment included, and Vusi’s without a balloon payment.

Tshepo pays R1 000 less per month than Vusi, however he has a balloon payment of R80 000 to pay at the end of the 5 year financing period.  Even if Tshepo saves R1 000 every month for 5 years, he will not have saved enough over 5 years to cover the R80 000 balloon payment.

If Tshepo is unable to pay the balloon payment at the end of the financing period, he has the option to refinance the balloon payment for a 3 year period at R2 700 per month, increasing the total purchase price of his vehicle to R625 000 (that is a total of R225 000 paid in interest over 8 years!).

The problem that Tshepo now faces is that his vehicle debt is worth more than his car, and should the car be stolen or written off, Vusi’s insurance pay-out will be less than the debt owed on the vehicle.

In summary, Tshepo paid R115 071 more in interest than Vusi, who did not take a balloon payment.

3.  How to “pop” the balloon payment?

• Save enough money every month in order to pay the balloon payment in full when it is due at the end of the financing period.
• Sell the vehicle and use the money from the sale to settle the balloon payment.
• Refinance the balloon payment.

4.  Pro’s of balloon payments

• Reduces the monthly instalments
• Can earn interest on the money saved on monthly instalments, if placed in a savings account and not spent on other things.
• No deposit is required for vehicle financing.
• Have time to build up financial status before balloon payment is due
• Makes it easier to own a more expensive vehicle.

5.  Con’s of balloon payments

• One could financially be unable to pay the balloon payment when it is due, which could lead to repossession.
• The vehicle financing option is more expensive than non-balloon payment options, as more interest is paid.
• There is no guarantee of obtaining a refinancing loan.

Consider the right vehicle financing option for you and buy what you can afford.