You might have all gone through that phase when the price tag on your dream car is really a stretch on your budget. After calculating your monthly sums, you realise that affording the regular repayment has turned into a challenge for you. Then what do you do in such a case? Well, you can enquire about another option - the availability of balloon or residual payment at the end of a financial term. In this post, we shall explain basic concepts such as what is a balloon payment, the meaning of ballooning, and is a balloon payment good or bad for you. After reading the blog, a prospective borrower will be able to know whether he should go for this option and the ideal conditions under which he can one opt for such a procedure.
Opting for a balloon payment? What does it actually mean?
A balloon payment is a fraction of your entire loan payment where you pay a lump sum amount at the end of your car or equipment loan term. This means you make reduced payments throughout your loan tenure, thus rendering this option quite advantageous for entrepreneurs. Businessmen facing a cash crunch in the beginning but expecting liquidity to move at a faster pace in the near future can immensely benefit from this contract.
When you require a vehicle for your business, you can now maintain a steady cash flow throughout the entire loan period. With reduced principal payments you are able to grow your venture and invest in your company with ease.
The real cost of balloon payment. Are there any hidden costs?
Let us illustrate this with the help of a small example. Assume that the price of a car or equipment you are planning to buy is AUD 30,000. Now if your lender quotes a balloon payment of 30% at the end of a five-year term, you shall owe him AUD 9,000 by the time your 60 months are over. By using an online calculator, we found out that your monthly payment in this case turns out to be AUD 546 (assuming an interest rate of 6.5%). Now, if we consider no balloon amount at the end of term, your monthly payment amounts to AUD 678.
So is a balloon payment the right option for you?
As seen above, going for ballooning does result in higher costs in the long term. Therefore, a natural question arises - why should we even choose this method? Well, before answering this question, let us guide you through the various pros and cons of a balloon payment.
● Lower monthly payment leads to more cash in hand. As a result you are able to maintain a regular cash flow for growth of your business. A borrower can even buy enough time for his investments to mature or incomes to change - thus allowing him to pay off the entire debt at the right time.
● By proving to your lender that you can pay a lump sum through the buildup of equity, you gain your lender’s confidence.
● At the end of your loan tenure, you also have the option to sell your vehicle and pay off the residual amount.
● Since you can now afford an increased loan amount, you can opt for a top-end vehicle rather than a base model.
● For some reason if you are unable to pay off your balloon amount, you might require to refinance your loan. As a result, your original 5-year tenure could get extended to a 7-year period or even longer.
● Failure to settle your balloon loan shall lead to a bad credit score.
● Lenders usually front load the interest amount. So when your balloon payment is due, you are paying your principal amount. During your loan tenure, you are settling only the interest on the loan; hence it is likely that you will owe more on the vehicle than it is actually worth.
When should one opt for a balloon payment?
Now that you have a basic idea about the advantages and drawbacks of a balloon payment, we shall guide you through the ideal conditions under which you can go opt for this and reap maximum benefits.
● Chattel Mortgage: One can use this type of loan mainly when purchasing a car or equipment for business use. Here the lender shall advance the full loan amount to the customer, who in return can claim complete ownership of the chattel mortgage vehicle after purchase. The client can settle his loan in regular installments and pay off the residual at the end of the contract term.
● Novated Lease: This agreement is done among employer, employee, and lender. As an employee, the loan payments will be made to your financer from your pre-tax income. Again, there will be a balloon payment at the end of the loan tenure.
● Finance Lease: This option is ideal when you wish to use your automobile for earning cash. The lender shall buy the car on your behalf and you will be required to pay a fixed monthly installment during the period of your lease. By the time the lease period is over, you can pay the residual amount to own the title of your leased vehicle.
● Fully Maintained Lease: Quite similar to the novated lease, this method however includes expenses related to vehicle running costs such as petrol, registration, insurance, and maintenance.
● Commercial Hire Purchase: Almost same as finance lease, this option requires you to pay a certain deposit amount through cash or trade-in.
Conclusion: The bottom line & major takeaways
A balloon loan can indeed be advantageous to the right customer under the right conditions. It is suitable for those who are habitual smart savers, experienced investors, and expectant beneficiaries. One can use this option to reduce taxes, premiums, and benefit employees. Therefore, with proper planning and detailed research, you can do away with drawbacks and unleash its full potential.