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How Does A Vehicle Balloon Payment Work?

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Have you ever heard of a balloon payment? When buying a new car, the term “balloon payment” is often thrown around when looking at finance options. This option is becoming increasingly popular in the South African market. Most banks and finance houses offer balloon payments when buying a car. How does a balloon payment work and more importantly, what are the consequences?

What Is A Balloon Payment?

A balloon payment is a lump sum that is required to be settled at the end of the finance term. Instead of paying off all the debt of the car, you are left with an amount that needs to be settled. The balloon payment amount can be between 5%  and 60% of the total purchase price.

The balloon, i.e. final lump sum figure, needs to settled in one large final payment. If the consumer is unable to settle this balloon, the creditor will often offer a re-finance option or offer a new loan agreement to pay it off.

Example from 1Life insurance:

 

Buying a car with no balloon payment

Purchase price: R200 000
Repayments calculated on: R200 000
Monthly repayment with 12% interest over 60 months: R4544.75
Total amount payable over term: R272 684.98
Amount owed at end of term: R0

Buying a car with 30% balloon payment

Purchase price: R200 000
Repayments calculated on: R140 000
Monthly repayment with 12% interest over 60 months: R3810.08
Total amount payable over term: R228 604.97
Amount owed at end of term: R60 000

As you can see the total cost of the vehicle will be R15 919.99 more expensive with the balloon option.

Why Do Credit Providers Offer Balloon Payments?

A balloon payment is an attractive option for car buyers as it can significantly reduce the monthly installment of the vehicle. This allows consumers to have access to cars that they would not be able to afford under normal repayment circumstances.

Credit providers would offer this option for two reasons:

  1. They will earn more interest if this option is taken
  2. They often tie the consumer into a re-financing option or a new loan option. This is because the consumer, more often than not, will not be able to pay the lump sum amount at the end of the finance term.

Is A Balloon Payment A Good Idea?

In general, it is always best to follow the rule – if you can’t afford it, don’t buy it. This rule is particularly important when it comes to long-term debts, such as home loans and vehicle financing. These types of loans take between 5 and 25 years to pay off, meaning that if your budget is tight you will be struggling to make the repayments for a long time.

A balloon payment allows you to buy a car that you would otherwise be unable to afford. That sentence alone should make you think twice about going for this option.

Because there is a lump sum amount due on the last payment, your outstanding debt amount is always inflated. This results in paying higher interest throughout the term of the loan as the balloon also attracts interest.

This means that the balloon payment option will cost you more in terms of interest and your vehicle will be more expensive in the long run.

{example source: 1Life}

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