• A balloon payment is a mechanism used by finance firms to make repayments more affordable to the consumer.
• An amount owing on the price of the vehicle is set aside, and the instalment amount is calculated on a lower value. • Wesbank CEO Ghana Msibi explains the positives and negatives of a balloon payment.
Vehicle finance firm Wesbank says consumers need to factor that a balloon payment into the finance agreement of one's next car purchase may come with some appealing benefits, but make sure these benefits are understood clearly and used wisely.
As with all financed products, responsible budgeting is key with such payments. Therefore consumers need to act sensibly during the term period to maximise what they offer.
What is a balloon payment?
A balloon payment allows a buyer to take an amount owing on the purchase price of a car and set it aside, meaning the monthly instalment amounts are calculated on a lower value – in turn making repayments more affordable. Essentially, the buyer is paying off a loan for most of the car, but not all of it. The amount set aside at the outset remains the buyer's responsibility and will need to be settled at the end of the agreed finance period.
"This type of payment is intended to assist with cash flow management at the start of a finance agreement, but only if you can afford it. It may help to ease the burden of monthly expenses, but buyers with balloon deals may need to use cash they’ve been saving to settle the balance owed at the end of term," Msibi says.
What are the benefits of a balloon payment?
Depending on the percentage of the balloon amount, the money saved on monthly payments should more than cover the costs of interest for a loan in order to refinance the lump sum of debt at the end of a balloon term.
A balloon payment gives consumers the option to save the money while driving the financed vehicle as opposed to apply for another bank loan to settle the outstanding amount owing on the vehicle after years of driving it.
Get familiar with the 'breakeven' point
Vehicle owners entering into a balloon payment deal should familiarise themselves with the term 'breakeven point'. The breakeven point occurs when the financed car's trade-in value matches the amount still owed to the bank. When calculating the breakeven point, it’s important to include the amount outstanding in the balloon debt at the end of the loan period.
Msibi goes onto explain that the breakeven point on a vehicle financed with a balloon payment is further down the line than it would be with a conventional instalment deal. "If your breakeven point comes at 36 months, but you simply cannot resist a shiny new car after only two years, the amount owed on your first car will be added to the cost of the new deal," he says.
"As such, you’re still paying off a portion of your old car while driving your new one. Consumers who do this multiple times could find themselves in financial trouble if, for example, there is a change to their income and financial situation, resulting in outstanding debt becoming unmanageable.
This is a dangerous trap to fall into, and we strongly advise our customers to consider changing cars only once the respective breakeven point has been reached. This will keep monthly repayments, the value of their current car, and the balloon debt evenly balanced."
A balloon payment isn't an alternative to a deposit
It is also important not to view a balloon payment as an alternative to an upfront deposit. A healthy deposit on a new or used car will always reap dividends further down the financial road, as it will not only bring your breakeven point forward, but it will also lower the monthly repayment costs and the deferred debt held in the balloon.