Understanding balloon payments in car loans: What Kiwis need to know

Some New Zealanders take out a loan when it’s time to buy their next car, whether they’re purchasing a new vehicle or a secondhand one. Borrowing the money can be a handy way to spread the cash flow impact of the purchase. It can also allow you to buy your new vehicle a bit earlier than you might otherwise be able to, if you were paying with cash upfront.

If you’ve been looking at financing a new car, you might have seen reference to “balloon payments” and wondered what balloons have got to do with cars. Here’s what you need to know about balloon payment loans and how they work, so you can decide whether they might be suitable for you if you are purchasing a brand new car.

What is a balloon payment?

In basic terms, a balloon payment is a larger, lump sum payment that you make at the end of a loan for a new car. It is sometimes also called a residual payment. With a regular personal loan for a vehicle, you pay the same amount each fortnight or month until you’ve repaid what you owe. But with a balloon payment loan structure, your repayments are smaller than they would be for a standard loan, until the end of the loan, when you make the final lump sum payment.

This can help from a cashflow perspective when you’re repaying the loan, and can also give you a bit of time and flexibility. The balloon payment might be 20 percent to 40 percent of the loan, so your monthly repayments only have to cover 60 percent to 80 percent of the purchase price plus the calculated interest.

Just as an example for illustration, if you’re borrowing $50,000 over 10 years for a car, at 15 percent interest, it might look like this: 

The exact payment amounts will vary according to the amount you borrow, the interest rate and any fees charged. 

How do balloon payments work in car loans?

If you decide to go ahead with a balloon payment loan, the process will probably look like this.

You’ll apply for a loan and have it approved by a car finance lender. Often, balloon payment loans are used by dealers of new cars, who will handle the loan application, too. 

You’ll agree on regular monthly payments that you’ll make over the term of the loan at a set interest rate. It’s common for a balloon payment loan to be over a shorter period of time, sometimes three years.  

You’ll decide on a lump sum that is due to be paid at the end of the loan term. This will clear the loan on your car.

Pros of balloon payments

There can be benefits to using a balloon payment loan. 

Your monthly repayments will be lower, which might help with your day-to-day cash flow. You might have the ability to save up the lump sum balloon payment over the term of your loan.

You may be able to afford a newer or more expensive car than you might otherwise have access to.

You could have options to refinance or sell the car when the balloon payment is due. If you’re the type of person who often trades up to a new car, this might be a solution that works for you.

It can be a sensible option for business owners for whom a vehicle is a business expense that is regularly upgraded.

Cons and risks of balloon payments

But there are some things to watch for when you’re considering balloon payment finance.

You need to be sure you’ll be able to cover the balloon payment at the end of the loan term.

If your strategy is to sell the car at the end to pay the balloon payment, you’ll need to make sure your car holds its value. There may be a risk that the car’s value at that point could be lower than the balloon payment, depending on the type of vehicle, the length of the loan and the size of the balloon payment.

You could end up paying a higher amount of interest overall because your principal owing remains higher for longer.

You could feel pressure to refinance your car or sell it when your loan is at maturity, and you’re facing the payment. This may mean you lose money on the initial price you paid for the car.

You generally can’t walk away from the loan if you’re not able to pay the balloon payment. In one case dealt with by a dispute resolution provider, a woman hit trouble when she lost her job before a balloon payment for her luxury car was due and was not able to cover it.

Balloon payments don’t tend to be suitable for people who have unstable income or aren’t disciplined with savings. 

Comparison

What happens at the end of a balloon loan?

When you get to the end of your balloon payment loan, you’ll have a few options to deal with the bigger lump sum payment, which will fall due.

Here are some of the most common things that borrowers do.

Who might consider a balloon payment car loan?

A balloon payment loan could work in some situations.

When you plan to keep upgrading your vehicle regularly. 

If you’re a business looking for fleet financing with cash flow flexibility. 

There are ways that other loan structures can help meet these aims, too. At better finance™, we can help you look at your options and think about what might suit you.

Who should avoid it?

Generally, a balloon payment loan may not be a good idea for people who have tight budgets, uncertain incomes or who do not plan to buy another car for a long time.

Tips Before Choosing a Balloon Payment Loan 

Here are some things you might like to think about before you opt for a balloon payment.

1. Run the numbers 

You can use a loan calculator, such as better finance™'s, to see what a standard car loan would look like. 

2. Compare the total costs

Take into account not just the monthly repayments but the total cost of the loan, including the balloon payment and interest charges. 

3. Consider the resale value of the car

What is a realistic, likely resale price or trade-in value for your vehicle? How well it may retain its value could influence whether a balloon payment is an appropriate option.

4. Seek advice

At better finance™, we’re here to help you look at your options. We can discuss what’s available and how it might work for you. 

It’s also a good idea to understand any fees that could be charged on any loan that you are considering.

Frequently Asked Questions (FAQs)

How big can a balloon payment be?

Balloon payments are often about 20 percent or 30 percent of the loan amount, but they can be larger. This is usually negotiated with the lender at the time you take out the loan.  The bigger your lump sum residual balloon payment, the lower your monthly repayments are likely to be – but the overall interest you pay will be higher.

Can I refinance a balloon payment at the end of my term? 

You may be able to, subject to satisfying a lender’s criteria. That could mean refinancing with the same lender or with a new one.  The lender will assess you as the borrower and the appropriateness of your vehicle. If your circumstances have changed, it could affect your application’s chance of success.

Do balloon payments affect my credit score? 

When you take out a loan, it can temporarily reduce your credit score. But as you build a history of making repayments, it can actually help to lift it. Ensuring you can pay the balloon payment will be important to protect your credit score.

What happens if I can’t pay the balloon? 

You’ll need to seek advice on your ability to refinance the loan. If you default on your balloon payment, it is likely to hurt your credit score.

Is it better to make extra repayments during the loan term?

Depending on the terms and conditions of your loan, you may be able to make extra payments to reduce the balloon payment. You may need to check that you will not be charged fees for doing this.

The right solution for your vehicle loan will depend on your personal circumstances. Some people enjoy the flexibility of a balloon payment structure, but others prefer the overall lower costs of a standard vehicle loan. We can help you weigh up the factors before you decide.

Balloon payment loans are an option to consider when you’re buying a new car, but they may not suit everyone. If you’d like to talk about your options, get in touch with the team at better finance™ today. We’re lending experts, and we’re here to help.