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Everything you need to know about balloon payments on a car

balloon payments - carballoon payments - car
balloon payments - carballoon payments - car

 

Everything you need to know about balloon payments on a car

When people go car shopping and see the high price tags, it’s no wonder that they settle for deals where they can to pay the absolute minimum monthly amount for the vehicle they choose. 

When they use a car finance calculator for South African car markets, they push the repayment term of their loan to the max (72 months) and take out a large balloon payment. In the moment where they see a relatively small monthly repayment value, they won’t feel the need to think about the long-term repercussions of their vehicle financing decisions.  

Increasing your repayment period means you’ll be paying a lot more money for your car in total due to an extended period of charged interest rates. And balloon payments, in general, are hardly ever a good financial decision. If you’re stuck with a balloon payment on your car or looking at all the options for financing a new car, here is everything you need to know about balloon payments.

 

What is a balloon payment?

When you’re applying for finance for a vehicle, your lender will give you the option of taking out a balloon payment amount. This is usually an agreed upon percentage of the price of the vehicle you’re going to buy (or the amount of the loan you’re taking out). This amount will then be deducted from the total value of the loan that needs to be repaid and charged with interest – consider it as a temporary downpayment.

The catch in all of this, however, is that at the end of the loan repayment period, you will be required to pay back the balloon payment lump sum on top of what you’ve already paid (with interest) on the vehicle.

Wesbank clearly explained the way a balloon payment works in an article on Engineering News. “A balloon payment of 20 percent on a vehicle of R240 000 will result in monthly repayments of R4 739.58 (over 60 months, at 11.5% interest). At the end of the finance term, the repayments will total R284 374.84. However, the buyer will still owe a 20 percent balloon payment – or R48 000 – thus bringing the total price of the vehicle to R332 374.84.”

The only appeal of a balloon payment is a lower monthly instalment, but it only provides temporary financial relief with more disadvantages than it’s worth.

 

Disadvantages of a balloon payment

Choosing to finance a car with a balloon payment should not be your first option. But not everyone is aware of all their car finance options and, to be honest, it’s difficult to turn down an upfront offer with low monthly repayments.

The obvious disadvantage of having a balloon payment on your car is that, by the end of it all, you’re going to increase the total cost of your car. This means you would end up paying more for your vehicle than it’s actually worth. This places you in an upside-down loan situation. So, when we say that the balloon payment percentage that is removed from the loan repayment amount owed is temporary relief, it’s because, in the end, it’s only going to increase the total cost of your car.

It’s one thing to be able to afford a monthly repayment figure but, with a balloon payment, you’re looking at a lump sum that needs to be repaid in full at one time. If you’re going to take a balloon payment, you better start saving every month throughout your loan repayment period to ensure that you can afford the 20 odd grand (or more) at the end of it all. If you can’t, this balloon payment could put you at risk of falling into more debt.

 

You have a balloon payment due, now what?

If you already have a balloon payment due, there are a few options available to you to make it work.  

  • Refinance: 60 days before you are required to pay your balloon payment, you will be able to refinance your balloon amount. The repayment of this balloon amount will only kick in once your car loan payment term comes to an end. This will make it easier for you to afford the balloon payment, but will also subject it to an interest rate, further increasing the total amount paid for your car.
  • Trade-in: There is the option of trading in a car with a balloon payment still due. What would happen is that the balloon payment amount would be deducted from the trade-in value of the vehicle. Should it not cover the balloon payment, you would then be required to cover the rest or refinance the remaining amount. It’s a similar scenario when selling a car with a balloon payment.
  • Pay it off: The simplest way to be rid of your balloon payment is to pay it off in full when it’s due.
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