When is it a good idea to use a balloon payment?
A balloon payment is a lump sum that's due at the end of the loan term. It is good because it will:
- Lower your loan repayments
- Allow you to defer payment for part of the total loan amount
- Give you breathing space to sell your car privately rather than trade-in
- Make it easy to upgrade at the end of the loan term
When should you choose a balloon payment
Balloon payments are most commonly applied to commercial loans secured against an asset, but they may be available for other types of car finance too.
Balloon payments for commercial car finance
The interest on commercial car finance is tax deductible. Taking out a balloon payment will increase the proportion of your outgoing cash flow that's tax deductible.
At the same time it will increase the total interest you'll pay for the loan, so you'll need to weigh up whether this cash flow benefit is worthwhile in the bigger picture of your business finances.
Novated Leases and Chattel Mortgages are two types of car finance that have a balloon payment.
Commercial car finance will often be a chattel mortgage with a lump sum balloon payment due at the end of the loan term. For this type of car loan, you'll need to use the car more than 50 per cent for business purposes. One advantage for the business is that upgrading your car is as easy as refinancing your balloon for your next car loan - we'll discuss this more below.
Balloon payments for private car finance
Balloon payments may also be structured into private car finance, in fact a balloon repayment is required for a novated lease. There's legislation that specifies what the minimum balloon amounts are for novated leases, and lenders will give you an offer that sits inside these guidelines.
If you specifically want a balloon payment to help you to purchase a car, mention this to your car loan service person.
When to choose a balloon payment
You might consider getting a balloon payment with your car loan if you're buying a new car or a used car that's less than five years old.
1. Lower car finance repayments
The primary reason that you would choose to take a balloon payment is that it means lower monthly car finance payments during your loan term, so it's easier on your cash flow.
2. Privately sell your current car
Getting a balloon payment that matches the value of your existing car gives you some breathing space to sell your car privately, rather than taking a low trade-in value when you upgrade to a new car.
Check with the lender how additional repayments affect your car loan if you take this option. You might need to stash the money from the private sale into a high-interest account until the end of your loan term.
Some lenders will allow you to put extra payments towards the principal loan amount without penalty, remember if you do this, you will still be required to pay the balloon amount at the end of the loan term.
3. Expecting lump sum income
Whether you are running a business, or you are an employee, varying pay structures can mean your income isn't always the same. A balloon can really help to make your car purchase affordable if your income is irregular.
With a lower regular car payment that fits within your regular income stream, you can save lump sum payments towards the car loan balloon when it falls due.
4. Cash flow for upgraders
If you are a business that regularly upgrades its cars or a private individual who likes to drive newer cars, then using a balloon payment that will be refinanced into your new car loan can work to keep your repayments low.
At the end of the loan term, the car will often be worth at least as much as your remaining balloon, giving you the option to simply trade in and upgrade. You may also sell the car privately and choose to refinance the balloon amount into your next car loan.
What you need to know about balloon payments
You will be paying interest on the amount of the balloon, so try to keep it as small as possible. Businesses will often set the balloon to the estimated value of the car due to depreciation at the end of the loan term.
You'll need to pay out or refinance the balloon amount when it falls due to finalise your car finance agreement.
What are the alternatives?
Using a car finance deposit will decrease your repayments, and you won't pay interest on the amount.
Do you want to find out more about your car finance options? Getting some advice from a car finance broker will allow you to compare balloon payment options from a range of lenders, and get all of your questions answered too.