What Is A Residual Value Or Balloon Payment?
If your broker suggests an offer from a lender that has a ‘residual value’ or ‘balloon’ payment as part of the loan contract, this means that in return for making reduced payments throughout the loan term, there is a lump sum payment due at the end of the loan contract.
If you are financing a car for business, this helps you to maintain your cash flow throughout the loan term, allowing you to grow and invest in your business.
The repayments are reduced because you pay less of the principal loan amount during the loan term. This amount is offset by the balloon payment at the end of the loan term.
How much will the final vehicle balloon payment be?
The balloon amount is expressed either as a percentage of the principal loan amount, or as a dollar value amount.
There are fixed minimum payments for all Lease car financing options - if you are considering a Chattel Mortgage, Finance Lease, Novated Lease, Fully Maintained Lease or Commercial Hire Purchase, the minimum amount of the balloon payment is set by the Australian Tax Office:
ATO Minimum Residual Value Guidelines
Length of Lease
Minimum Residual Value (% of principal)
Advantages of a loan with a Balloon Payment
- Keep your money where it matters
- reduced repayments mean you have more cash on hand
- Increase lender confidence
- by proving that you can make a lump sum payment after building equity through regular payments.
- Increased maximum loan amount
- ability to finance a top end vehicle rather than a base model
- Facilitation of cash flow allowing you to grow your business
- No requirement for up-front equity
- closer matching of the repayment of a car loan principal with the vehicle’s value as it depreciates over time.
When are Balloon payments used?
Balloon payments are used in the following types of loans:
- Chattel Mortgage
- This loan is the most frequently used when the vehicle primarily for business use.
- No deposit is needed.
- The lender advances the full sum of the car price, so the client can take full ownership of the chattel mortgage car upon purchase.
- This means the business can claim the full amount of the GST as an input tax credit in the same financial year.
- The lender then registers a mortgage over the car ‘by registering a ‘fixed and floating’ charge with ASIC. This appears on the the Personal Property Security Register.
- The client has a contract to pay the lender the agreed amount in regular installments. There is often a balloon or residual payment at the end of the term.
- The contract is generally 24 to 84 months.
- You can calculate your potential repayments with a chattel mortgage repayment calculator.
- Novated lease
- A novated car lease is an agreement between an employer, employee and their finance company.
- It is often referred to as purchasing a car through ‘salary sacrifice’.
- The vehicle belongs 100% to you, the employee, and you have complete choice over which vehicle you purchase.
- Your employer makes payments to the finance company from your pre-tax income.
- There will be a balloon payment at the end of the loan term. This is the only payment which GST will apply to, saving you up to $5, 000 on the total value of the car.
- Using a novated lease calculator you can work out what your repayments will be and how long you'll have the lease for.
- Finance Lease
- Used by corporations, partnerships, sole-traders - most suitable when you need the vehicle to make an income.
- Flexibility to change the vehicle when your requirements change.
- The lender purchases the car on your behalf, and you pay a fixed monthly payment to use the car for the during the contract.
- At the end of the lease, you have the option to pay the residual value and take clear title to the car.
- Fully maintained Lease
- This the same as a novated lease, but the monthly payments also include vehicle running expenses, including petrol, registration, insurance and maintenance.
- Commercial Hire Purchase
- Similar to a finance lease, the only difference is the option for a deposit at the beginning of the contract. This can be cash or a trade-in.
- At the end of the contract, the lessor can pay a residual amount and take ownership of the vehicle.
Who is a Balloon Payment suitable for?
The Smart Saver
If you habitually ‘save for a rainy day’ by tucking away a few dollars every week, you’ll easily save the amount you need for the final big payment.
The Savvy Investor
A balloon payment is for you if you are a savvy investor who uses their capital to earn before your debts are paid off.
The Happy Beneficiary
If you are certain that you will receive a lump sum payment that will cover the balloon and will be paid before the end of the loan contract, this type of loan might be suitable for you.
What happens when the contract is up?
There are several options at the end of a loan that has a balloon payment attached. To explore these, let’s see what happened to our 3 loan recipients above:
Case Study 1: Jane The Smart Saver
Jane has diligently put away 15% into a separate savings account each week over the last 3 years, and when she reaches the end of the loan, she has more than enough to make the final payment on her Mazda 3.
However, her daughter, who moved to Canada last year, is having a baby, and Jane decides that she would rather spend the money taking a trip to see her daughter and new granddaughter.
Jane speaks to her finance broker, who arranges to refinance, rolling the balloon payment into an continuing loan until the final sum is paid.
Case Study 2: Josh, The Savvy Investor
Josh, the Savvy Investor, has managed to use the money saved on repayments to invest in marketing strategies to grow his kitchen showroom and generate more business. After speaking to his accountant and to his finance broker, he decides that he can afford an upgrade.
Josh trades in the ute he bought with the first loan. The trade in covers the value of the balloon payment, and his broker arranges a new loan contract for the new car.
Case Study 3: Julie's Getting An Inheritance
Julie, the Happy Beneficiary, was delighted that her Grandfather left his Audi to her in the will, in addition to the sum of money that she expected. No longer needing the Holden Barina that she bought with the car loan, at the end of the loan contract she pays the $5000 owing on the car in cash, finalising the loan.
She decides to keep the Barina for her son to learn to drive in.
A finance broker can use their skill and experience to identify which type of loan would best support your business, commercial and individual needs. A broker will help you to select the loan option with the best tax benefits, saving you money.
Depending on your business situation, the right loan can be used to reduce tax, payroll tax and Work Cover premiums, while benefiting employees.