Are balloon payments a good way to save on car repayments?

Buying a car is a big financial commitment and figuring out how you're going to pay for it beforehand is the best way to make sure you stay within your budget. If you want to buy a car and are looking for ways to save on the monthly repayments, you might be considering a balloon payment or residual value loan. However, with these options it can be difficult to settle the outstanding balance on the car at the end of the repayment term, so it's important to look at all the factors before deciding on this route. Let's look at what these options entail and whether they are right for you.

What is a balloon payment?

A balloon payment is a lump sum which the car owner pays at the end of a vehicle finance term. It's the final payment due, and the borrower and loan provider will agree beforehand what percentage of the total loan should make up the balloon payment.

Many buyers choose a balloon payment option because it could drastically reduce monthly repayments, making their finances more manageable. In theory, because buyers are paying less every month, they should have extra money to put away to save for this lump sum payment at the end. However, budgeting and saving this kind of money can be challenging! If a buyer can't pay the balloon payment when it's due, the car can be refinanced or sold.

Balloon payments can make your life easier at first, but you need to make sure you have that lump sum amount ready or considered your options when your finance term ends. So, what do you do if you're not certain you can save that lump sum amount in time? There is another similar option which requires less of a commitment from you than a balloon payment – a residual value loan.

What is a residual value loan?

A residual value car loan applies the same principles as a balloon payment but works a little differently. The idea is for you to lease a car for a specified period of time and pay a lump sum at the end of the period if you wish to own the car.

You'll still pay a monthly amount during your lease period, just like you would for a balloon payment; however, you're not committing to buying the car at the end. If you choose to, you can return the car to the vehicle finance provider or sign a new lease agreement for it and continue to lease it for another set period.

Buyers can get lower premiums on new cars, but second-hand cars could have higher monthly premiums because their value usually depreciates more. The loan provider may monitor the number of kilometres you travel in the new car and could penalise you for high mileage or a lack of maintenance. This is because a car's mileage and condition affect its resale value.

Is a balloon payment a good idea?

For buyers who can save the amount needed, a balloon payment can work to their advantage, and for investors, it can free up short-term capital. In most cases, however, balloon repayments are an easy way to find yourself in debt. Most people who are average income earners that can't afford the original repayment amount can also not accrue the amount needed to pay the lump sum at the end of their repayment period.

It isn't always easy to think about the long-term ramifications of balloon payments. Many people know how easy it is to go over their budgets when they have their hearts set on a specific car, especially when a balloon payment option looks so attractive. Unfortunately, people in this position often can't pay the lump sum at the end of the finance term and debt problems follow. As a safeguard against this, financing companies often require evidence that buyers will be able to afford a future balloon payment.

Unless you're absolutely sure you can afford the balloon payment later on, you're better off buying a less expensive car. To save money on your total finance deal, choose the shortest repayment period possible and consider paying a deposit on the vehicle, both of which could save you thousands of rands.

What are the pros and cons of balloon payments?

For first-time buyers, a balloon payment or residual car loan can be confusing. Before you sign anything, make sure you understand all the terms of the contract and what is expected of you. If you're unsure about whether a balloon payment is right for you, look at our list of pros and cons below to help you decide.

Pros of a balloon payment

• A deposit is usually not required.
• It could help with your cash flow management.
• You can free up short-term capital and cover finance gaps.
• You'll be charged a lower monthly repayment fee.
• An increased loan size means you can afford a new or more expensive car.

Cons of a balloon payment

• The loan provider may not approve refinancing of your balloon payment if you can't pay it when the time comes.
• Not being able to afford a balloon payment may lead to a cycle of debt because you will need to refinance it.
• If you default on your balloon payment, you may be forced to sell the car, sometimes for less than what is still outstanding on it. If this happens, you could end up without a car and still be in debt.
• A loan that includes a balloon payment is riskier and more complex than a traditional loan with a standard repayment schedule.

Buying a car is one of the biggest financial ventures you'll embark on in your lifetime. Yes, you could save money on your monthly car repayments with a balloon payment, but you're not necessarily saving over the long-term and there are risks involved. We're sure the car you're eyeing is super tempting, but the long-term financial impact could be detrimental to your future without the correct preparation.

Regardless of whether you opt for a balloon payment, your loan provider may insist that the car you want to buy is insured. With our online comparison tool, your car cover is one of the easiest ways to save money on your monthly vehicle costs. Compare car insurance quotes in minutes on the hippo.co.za website today.

The information in this article is provided for informational purposes only and should not be construed as financial or legal advice.