Balloon payment car loan guide

Balloon payment car loans may be misunderstood by some. They can be useful, but aren’t always right for everyone.

So, if you’re in the market for a car loan, it’s vital to have a good understanding of what you’re dealing with if you’re to pick an option that’s suitable for your needs. This guide will give you some key information that could help you to make a more informed decision.

'Balloon payment’ may sound like a strange term, but once you understand what it is, it’s fairly apt. You see, it refers to a larger than normal, or inflated, payment at the end of a loan term.

Lenders that offer car loans with balloon payments lower their loan’s monthly repayments right up until the end of the loan term. The last payment is then much, much larger to compensate for the lower than normal loan repayments charged up until that point.

Typically, a balloon payment will be a specified percentage of the total loan amount, such as 30 per cent, for example, which the lender will set when they finalise the loan terms. You may have the opportunity to negotiate how much that percentage will be.

A car loan is often like any other kind of loan. It has an interest rate and several fees and charges, and it requires you to make monthly payments to repay the loan. However, if your lender’s contract includes a balloon payment on a car loan, it’ll work slightly differently.

When there is no balloon payment, your lender will calculate the loan amount plus any interest you’ll have to pay and any fees (like monthly or yearly account fees), into frequent repayments based on the loan term. The frequency of repayments may vary between lenders, however many will provide an option of monthly, fortnightly or weekly.

When a balloon payment is included at the end of a car loan, the lender is allowing you to reduce the value of the frequent repayments without extending the life off the loan. That means the final, residual payment needs to be larger than the other payments. And, because the interest each month is calculated on a larger amount of money (because lower repayments mean you pay off the loan more slowly), it also means balloon payment car loans can increase the total loan cost) compared with equivalent loans that don’t have balloon payments.

When you get to the end of this kind of loan, you make your final payment and finalise the loan as you would any other loan, it’s just that the final payment is bigger than normal.

Note, car leases can also have residual payments. These are a little different to car loan balloon payments. Instead of just being a percentage of the loan amount, a car lease residual payment will generally represent the value of the vehicle at the end of the lease.

While the negatives of a balloon payment car loan may seem significant, there may be situations where getting a car loan with a balloon payment could make sense, for example:

• You’d rather avoid higher repayments right now, but you’re confident and comfortable you’ll have the ability to pay the balloon when the time arrives
• You’re planning on upgrading your car near the end of your loan term and will pay the lump sum payment from the proceeds of the sale of the car (you might then decide to apply for a new loan to fund your replacement vehicle).

Regardless of whether you decide to apply for a loan with a balloon payment or not, some of the next steps you might take in choosing a car loan is comparing a range of options and checking the eligibility requirements, such as credit score, before you apply for a loan you want.

To help you with that task, you could compare a range of car loans with Compare Money, which includes some handy information to help you compare and gather some key information to help pick a car loan that’s suitable for your needs.