Managing your finances can be difficult, especially when it comes to long-term investment such as a car or equipment loan. So many finance-related words are thrown at you that you can get confused trying to decipher their meaning. However, it is important that you understand certain loan and investment terminologies for greater clarity. Here, in this blog, we shall explain to you a very important term in the field of auto finance – residual value or balloon payment. As you read further, you will have a clear picture of the various aspects linked to this option – such as what is a balloon payment on car finance, what are the major considerations when applying for this process, and what to do if a balloo payment falls due? So let us understand
Meaning Of Residual Aka Balloon Payment
A balloon payment is a lump-sum amount that is attached to your vehicle loan. The value of this amount exceeds your regular monthly amount in value and can be paid either in regular intervals or at the end of your loan tenure. This complete agreement is termed as a balloon loan and is utilised by borrowers to decrease their monthly repayment amount. Lenders normally reduce interests for prospective loan applicants who hold a higher equity. Since several individuals usually do not possess thousands of dollars in hand, they find it easier to go for ballooning on their auto loan. In a nutshell, by offsetting reduced monthly instalments with a higher lump-sum at the end of the loan term, a lender ensures lower interest rates for the borrower.
How does a balloon payment lower monthly instalments? Let us answer this through an example:
Inference: You save an amount of AUD 120 (620 - 500) on a monthly basis when you go for the balloon loan option.
What Should Be My Major Considerations When Applying For A Balloon Loan?
A balloon loan is an ideal choice for two categories of borrowers:
● Those who want lower monthly payments
● Those who can’t afford a down payment
In either scenario, our experts have only one advice – plan in advance. Save a certain amount monthly and have your investments in place. Refinancing a balloon loan is an extremely bad idea. Even though you might be able to extend the length of your loan from five years to a seven-year term, this is not guaranteed. Under the worst case, you can even end up losing your car for which you had been paying interest through the years.
What Are My Options When A Balloon Loan Falls Due?
It is simple. You can pay your residual or balloon amount as a single lump-sum amount at the end of your car loan's term. Let us run you through some more options to make you aware of other scenarios in this case:
● Yes, paying cash and settling the loan for good is the best choice. But you can also ask for approval from the designated authority and refinance your balloon payment into a new loan – i.e. continue with your present loan so as to cover the entire residual value.
● Another option is to sell your current car or equipment and utilise the sale amount to pay off the balloon amount. Subsequent to this, the borrower can apply for another loan to buy a replacement vehicle.
A lender would calculate your balloon payment based on the residual value of your car. This is inclusive of the make and model, past performance records, and mileage of your purchased vehicle. A balloon loan is usually approved to borrowers who have a good credit history and are opting for a new or nearly new vehicle.
Does A Balloon Loan Affect My Credit Score?
Predictability and credit scores are two sides of the same coin. If you follow a proper financial plan and pay off your instalments on time, a balloon loan can actually improve your credit score. Failing to do so will obviously lead to a bad score in your credit history.
Bottom Line & Way Forward
Since financing a car or equipment is a long-term investment, you should discuss with an experienced finance consultant before opting for a balloon loan. This will help you in maintaining a correct balance between your monthly instalments and end-term commitments. You can decide from a pool of several lenders with flexible financing options. According to your individual financial position and requirement, go for a lender who finally fits the bill.