The big pay-off: How balloon payments work

By Brad East

If a dealership offers you finance, they nearly always add on a balloon payment. These rarely work in the borrower’s favour but with clever sales techniques they can make a car loan look a lot more appealing. Knowing how balloon payments work makes a big difference when taking out a loan and can have a huge impact on how much your vehicles actually costs.

Balloon payments are the last fee of a loan to be paid off at the end of the payment schedule. They’re based on the monthly instalments paid and the overall amount borrowed.

For anyone with a loan, a balloon payment always feels like a major hurdle. You know it’s coming, yet it doesn’t make paying off that large sum any easier.

However, understanding their purpose and why they are there can go a long way into ensuring you have the means to pay for it.

With that in mind, how do balloon payments work?

How balloon payments work

As with any major financial decision, you want to make sure you’re fully aware of what you’re signing up for. Balloon payments can help some people, but they can be a huge problem for others.

When you secure a car loan, working out how to pay back the loan itself is very important. It’s why lenders spend their time explaining all the terms to make sure you’re aware of everything in the fine print.

One way to make repayments easier to manage on a long-term basis is to agree to a balloon payment. What this does is allow the recipient to make one large payment at the end of the repayment schedule at the expense of smaller monthly payments.

Instead of paying a set percentage of the entire amount of the loan in one go, you can set aside a specific amount to pay at the end whilst paying off smaller amounts month-by-month.

On most occasions, the balloon fee presents a sizeable chunk of the loan amount but not more than the instalments themselves. The fee itself is often between 20%-40% of the total value of the loan.

Once these terms are agreed upon, the recipient can receive their vehicle while paying off its value every month.

Want to see how it might affect your loan? Add a balloon payment into our car finance calculator and see how it changes your repayments.

Advantages of a balloon payment

For many, agreeing to a balloon payment comes down to one main ploy. It keeps monthly expenditure down making life easier in other areas.

With any other bill, your loan repayment adds to the outgoings in your household. With the cost of living higher than ever before, every last cent counts.

By putting a balloon payment into the contract, you reduce the regular payments being made which you can use to put towards groceries, rent or other expenses. Alternatively, you can put those savings aside into a separate fund, especially for paying off the amount at the end of the repayment schedule.

However, that’s not the only trick of having it. If you have owned your car for several years, there’s a good chance that its overall value has dropped since you bought it. That means, that instead of spending large amounts to pay off the balloon fee, you can sell the vehicle instead.

If you sell the vehicle for a decent fee, that money can go to paying off the balloon fee meaning that you might be able to used money saved for it on other ventures. It effectively nullifies the fee’s existence.

Disadvantages of a balloon payment

Just because a balloon payment could potentially save you money, it isn’t a guarantee that will. Having a fixed lump sum to pay is never going to be easy – particularly when you know it has been there for several years.

For the unprepared, trying to pay off a large fee at once can be extremely difficult. If you find the fee deadline approaching and you can’t pay it, you may have to look at other options including refinancing and taking out another loan.

This isn’t the only potential problem. As the balloon payment is set at the beginning of the loan itself, it will mean you are likely paying more than what the vehicle itself is worth. If this is the case, it won’t save you more money than a regular repayment scheme might over the same period.

It means that when you are looking into finalising your car loan, check the payment schedule and see whether a balloon fee is worth it – particularly if your plan stretches over a few years.

Paying off the balloon payment

For many people, the notion of paying a balloon payment will always feel daunting. However, there are more options than simply paying off the fee when that deadline comes. The options usually presented to the vehicle owner are:

• Paying the fee
• Selling the vehicle to pay the fee
• Refinancing or extending the loan

For those who are prepared or well-off, paying the fee is a straightforward option. Doing that gives you complete ownership of the car and no more financial burdens. However, this fee isn’t exactly a small amount. If your car cost $50k, a general balloon payment would be around $10k-$20k.

If you feel that the car might not be worth the value you paid for it originally, there is the option of selling it or trading it in. When you do this, you can put the proceeds towards paying off the balloon payment directly.

In some cases, the vehicle might hold enough value that it sells for a decent price and that money pays off the entire fee. However, for many, it will help lower the fee enough to pay the rest with savings or spare money. Should you look to trade it in for a new vehicle, the fee amount will be added to the price you pay for your new vehicle.

For those who don’t have the money, there is the possibility of refinancing the fee itself. This would allow you to pay the amounts in instalments set out with the lender. However, some lenders may not let this be an option forcing you to find an alternative to make the overall payment.

In some other circumstances, a lender might even let you carry the fee over to a new loan should you look to get a completely new vehicle. Like the previous loan, this fee would remain the same and be expected to be paid at the end of that loan.

FAQ

Do all car loans have a balloon payment?

No – a balloon payment is only included should the recipient sign for it. It’s seen as an alternative way to pay off the loan if the regular instalments are too much to maintain. Many car dealerships will offer it as a way to make payments look lower but overall you’ll end up paying a bit more.

Are balloon payments a fixed amount?

Yes – the fee is a fixed lump sum that doesn’t change no matter how long the repayment schedule is. That’s why knowing how balloon payments work is important before finalising your car loan.

Can balloon payments be extended?

Sometimes. If you decide to take out a new car loan, then you can transfer the balloon payment from the old loan to the existing one. However, the fee may be different depending on what the terms of the new loan might be.

Conclusion

Learning how balloon payments work can make a big difference in how you structure your car loan repayments.

If you’re savvy at saving, then it can make it easier to free up some spare cash in everyday life. However, you are putting forward a big payment at the end of the loan schedule and this could ultimately make the loan more expensive than the overall value of the car itself.

That’s why knowing how balloon payments work is important before purchasing your next vehicle.

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