OPINION | Vehicle finance: Are balloon payments still relevant?

  • In SA, access to finance and own transport is intertwined with our socio-economic and socio-political narrative. 
  • Extended finance terms and balloon payments may appeal now more than ever.
  • Balloon finance, as one option, is often misunderstood.

Falling interest rates may tempt one to splurge on big-ticket items such a new vehicle, whether to catch-up with the Khumalos or the Joneses or to shift to a better mode of transport.

But whatever the underlying motivation, a loan may be necessary to supplement any savings to complete the transaction. 

During these tough times consumer spending is under pressure and fewer households can make ends meet, let alone save. Extended finance terms and balloon payments may appeal now more than ever. The automotive industry, eager to reboot weak vehicle sales, under strict health and safety guidelines could package an array of enticing financing solutions.

It is not improbable to expect a surge in high loan-to-value loans - a term lenders use in the financing of mortgages or vehicle loans. Add to that extras such as warranties and the funding of shortfalls from previous trade-ins.

Consumers turning to vehicle finance have options to reduce the monthly instalment, including extended repayment terms or a balloon payment, an alternative that has been a lifeline to many consumers who could otherwise not afford to drive a car of their choice.

How are balloon payments still relevant in an environment where consumers are more financially stretched due to the consequences of the Covid-19 pandemic? 

In SA, access to finance and own transport is intertwined with our socio-economic and socio-political narrative. Vehicle finance can activate small enterprises or unlock a dream in an emerging middle-class household.

With any credit option, responsible risk assessment criteria, underpinned by sensible regulation can create the correct conditions for its adoption and use in certain instances. In South Africa, regulators have stepped up their vigilance to ensure that financiers do not abrogate their duty to lend responsibly.

Balloon finance, as one option, is often misunderstood.

The balloon is a percentage of the loan which the consumer settles as a final instalment at the end of the contract period. This reduces instalments but the interest, paid monthly, is calculated on the total cost of the loan.

In comparison, a consumer opting for finance without a balloon payment is not required to pay a lump sum on maturity of the loan and can derive the benefit of the vehicle’s full value when trading in or selling it. With a balloon payment, you must settle the balance before you are able to take ownership of the vehicle at the end of the contract or sell it.

Let’s consider an example of a balloon finance structure.

Financing a R400 000 vehicle over 60 months with a 40% balloon payment (13% interest, no deposit) will reduce the monthly instalment from around R9 100 (on a contract without residual) to about R7200, but the interest paid over the life of the loan will be much higher.

The final instalment (the balloon payment) would be R160 000. At the end of the original 60-month loan period, the vehicle could have depreciated in market value to below R160 000, which leaves the consumer with a shortfall to cover should they wish to sell the car.

The consequences need to be weighed. Consumers unable to repay the lump sum can seek refinance but doing so more than once increases the quantum of the balloon significantly and exposes the customer to a higher risk of defaulting on the large debt.

The power remains in the hands of customers through smart planning, opting to reduce the balloon percentage early in the contract or paying extra to shrink installments.

Consumers need to be aware that various financing options address specific requirements. A balloon gives a customer the option to pay for use of the vehicle for a certain period while the value of the car is maintained. Keeping it for shorter also means the consumer has not yet repaid enough of the loan to settle it commensurate with the value of the vehicle at that point and the balloon must still be repaid.

An option is to take out a loan and balloon appropriate for the period you want to keep the vehicle. A financier can advise on the appropriate balloon.

Adding a vehicle to your personal finances constitutes a significant cost. The unprecedented difficulties of Covid-19 require unmatched penny-pinching from consumers and financiers to exercise extra care to invest in a healthy customer. This will benefit the entire economy and overall banking system.

The winning formula is being honest with oneself when it concerns needs and affordability, approaching a responsible and accredited financier and opting for a financing plan that suits your current and future needs.

The correct financing option could be the difference between your aspiration attained or a nightmare realised.  

* Mkhize is the Managing Executive for Vehicle and Asset Finance, Retail and Business Bank, Absa Group. Views expressed are his own.

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