Balloon payments: The pros and cons
A balloon payment can be used strategically to finance a new vehicle, but while the short-term benefits are appealing, it should still be considered within the context of your affordability. Furthermore, the looming lump sum payment at the end of the loan period must always be kept in mind as it will have an impact on your payments later.
Here’s what to consider when making an informed decision to buy a vehicle:
What is a balloon payment?
With regular financing, you have an instalment at a specific interest rate that you will pay off in a certain amount of time. With a balloon payment (or residual), you’ll pay instalments for a percentage of the loan amount over a term, and at the end of that term, you agree to pay another amount over the remaining term.
Therefore, you pay off a part of the loan, and at the end of the term, you still owe an amount before you can take ownership.
When does it make financial sense?
The purpose of a balloon is to make your monthly payments more affordable, taking pressure off your budget. The benefit is that you can drive away with a new car, have a smaller initial debt owed and have an extended period to pay off the car.
If you have the means or you’ve budgeted the money you saved on the monthly repayments and you’re planning to put that towards the outstanding amount owed or use it to pay off other debt and free up cash flow, a balloon payment can work for you.
What to look out for
It’s important to remember that at the end of the initial repayment period, you still need to pay an outstanding amount. Therefore, it’s still under the bank’s ownership until you’ve paid off the residual amount.
It’s critical to consider the long-term affordability of paying for this vehicle: can you afford the ongoing costs, or will the continued expense influence your ability to reach your financial goals?