One important factor to take into account when choosing a car loan is whether or not you want a residual value or “balloon payment” on the loan, and if so, how much you want it to be. The amount of a balloon payment can have an impact on both the amount owed at the end of the loan and the amount of regular monthly repayments. For the purposes of this article, we’ll refer to it as a balloon payment. If you discuss this option with one of our committed finance consultants, they will be able to clarify whether you’re talking about balloon or residual payments.
Continue reading to find out how it impacts your loan and some things to think about when selecting a balloon payment.
When it comes to financing your next big purchase, like a car or a piece of equipment, you’ll likely encounter terms like “residual value” and “balloon payments.” While these terms may sound confusing, understanding their differences can help you make informed decisions about your loan options.
Residual Value vs. Balloon Payment: What’s the Difference?
Both residual value and balloon payments refer to a pre-agreed payment due at the end of a loan term. However, the key difference lies in how the amount is calculated:
- Residual Value: This is based on the estimated market value of the asset at the end of the loan term. It’s typically used in finance leases, where you essentially “rent” the asset and return it at the end of the lease period.
- Balloon Payment: This is a fixed amount agreed upon at the start of the loan, regardless of the asset’s actual market value at the end of the term. It’s commonly used in chattel mortgages, where you own the asset outright after completing the loan payments.
Example:
Imagine you’re financing a $50,000 vehicle over five years.
- Residual Value: If the residual value is set at 30% ($15,000), you’ll pay off $35,000 over the five years and then make a final payment of $15,000 at the end.
- Balloon Payment: If you opt for a $15,000 balloon payment, you’ll pay off $35,000 over the five years and then make a final payment of $15,000, regardless of the car’s actual market value at that time.
Which Option is Right for You?
The best option for you will depend on your individual circumstances and financial goals. Here are some factors to consider:
- Budget: If you have a tight budget, a lower monthly payment with a larger balloon payment at the end might be more manageable. However, remember that you’ll need to have the funds available for the balloon payment when it comes due.
- Flexibility: Residual value leases offer more flexibility at the end of the term. You can choose to return the asset, purchase it for the residual value, or even extend the lease.
- Ownership: If you want to own the asset outright at the end of the loan, a chattel mortgage with a balloon payment might be the better option.
Additional Considerations:
- Refinancing: You can often refinance balloon payments over a shorter term, typically two to three years for vehicles and up to five years for assets with higher residual values.
- Market Value: If you choose a residual value lease, it’s important to research the asset’s expected depreciation to get an idea of the potential final payment.
- Financial Advice: Consulting with a financial advisor can help you understand the different loan options and choose the one that best suits your needs.
Remember:
- Do your research and understand the terms of the loan before you commit.
- Consider your budget and financial goals when choosing between a residual value or balloon payment.
- Seek professional advice if you need help making the right decision.
You’ll be in a better position to select a financing option that fits your budget and enables you to make an informed investment in your next major purchase if you know the distinction between balloon payments and residual value.
So, what is a balloon payment?
A balloon payment is an amount due in full to the lender at the conclusion of the loan term, following the completion of all scheduled monthly repayments. In exchange for paying the lender a lump sum at the end of the loan term, this enables you to repay only a portion of the principal of your loan over its term, lowering your monthly repayments.
What happens at the end of my loan term?
If you have chosen to add a balloon payment to your loan, the entire amount owed must be paid at the conclusion of the loan’s term.
However, there are generally a few options available when the balloon payment loan is due:
- If you want to keep your car, all you have to do is pay the balloon payment and complete the loan. You have two options for paying it: cash or, if approved, refinancing or “rolling over” your balloon payment into a new loan, which is just extending your current loan to cover the balloon.
- If you’re in the market for a new car, you can sell your current car and use the money from the sale to settle your loan balance and make the balloon payment. After that, if you’d like, you can buy a new car and apply for a new loan to pay for the purchase of the new car. The balloon payment can typically be incorporated into the switchover process if you’re trading in your current car in exchange for your new one, making things easier for you.
Balloon Payment Explained
FAQ
Is residual value the same as balloon payment?
What is a residual payment?
Is a balloon payment a good idea?
What is a residual payment on a loan?
Is there a difference between a balloon and a residual payment?
In short, yes, but the practical differences are minimal. Both a balloon and residual payment imply paying a defined amount at the end of your car loan, specifically designed to reduce your ongoing repayments throughout the life of your loan prior to the end of term.
Can I refinance a residual or balloon payment?
3) refinance the residual or balloon payment amount into a new loan. If you are approved, this means you will keep paying off your car. You may be able to refinance your residual or balloon amount owing with your existing lender or a new lender. The main thing is to find yourself a great deal. A car finance broker can help you to do that.
What happens if a loan has a balloon payment?
Very little of the monthly payments go toward the principal until the final months of the loan. This means that with a loan with a balloon payment at the end, you may still be upside down when you reach the balloon. If so, you may need to put some money down if you want to finance the balloon amount.