- A car loan balloon payment is a final lump sum payment, generally around 30-50% of the car's value, due at the end of the loan term
- It has the effect of lowering regular repayments
- However, balloon payment loans will see borrowers pay more in interest overall than for a standard car loan for the same amount
If you're in the market for a car loan, 'balloon payment' is a term you'll likely come across. It's a feature of many car loans and it pays to understand how balloons work and how they might suit your circumstances.
What is a balloon payment?
A balloon payment is an agreed-upon lump sum payable to your lender at the end of the car loan term.
Balloons are usually a significant portion of the loan amount, generally between 30-50%, that effectively cuts down monthly repayments over the course of the loan.
How does a balloon payment work?
The best way to explain balloons is to see how they work in practice. Let's look at an example:
Case Study
Car loan with balloon payment vs standard car loan
If Daniel takes out a $30,000 car loan for five years at 8% interest, his monthly repayments would be $608.
If he was to take out the loan with a 30% balloon payment of $9,000, payable at the end of his loan, his monthly payments would go down to $486. At the end of the five years, he would then have to pay the $9,000 balloon payment in full.
The table below compares the two scenarios Daniel will need to consider:
Cost of a $30,000 5 Year Car Loan at 8% Interest Rate (excl. fees) 30% Balloon No Balloon Monthly Repayments $486 $608 Total Repayment after 5 years (Principal + Interest) $38,148 $36,498 Interest Costs $8,148 $6,498 Total Cost Difference +$1,650 Source: Savings.com.au Car Loan Calculator
While many people take out car loans with balloon payments because their monthly repayments will be less, they will effectively be charged more interest over the term of the loan.
In Daniel's case, the loan with a 30% balloon will see him pay an additional $1,650 over the five-year period.
Why do you pay more interest with a car loan balloon?
When a car loan includes a balloon payment, the balloon amount is not paid down with regular monthly principal and interest repayments as it would be if it was part of a regular car loan.
However, you are still being charged interest on the balloon amount for the complete term of the loan, even though you don't have to pay it back until the end.
Deferring a large lump sum until the final payment sees you effectively paying down the principal more slowly while interest keeps accruing on the balloon amount.
There are some complicated mathematic formulas that underpin this but using the optional balloon repayment feature on our Car Loan Calculator will do the maths for you.
Why you might consider a car loan balloon payment
Yet despite paying more in interest, there are a number of reasons why borrowers might consider having a balloon payment on their car loan. These include:
Monthly repayments are less
As we've seen, monthly repayments are lower compared to a car loan with no balloon payment at the end. This can provide more cash flexibility, particularly for people who may have other expenses such as a home loan to service or are on lower incomes.
Allows you to borrow more
Balloon payments provide the added benefit of allowing borrowers to qualify for larger loan amounts. This generally gives them the option of saving for the balloon payment at the end, selling another asset to cover it, or selling the vehicle to pay off the loan.
Facilitates the turnover to newer vehicles
Some borrowers take out balloon loans with the intention of trading in their cars at the end of the term and using the proceeds to pay off the balloon. They can then apply for a new car loan to fund the purchase of a replacement vehicle. This strategy can be quite common for business car loans.
"Balloons can be suitable under a range of circumstances, including: However, a balloon will always cost you more over the full term. You would avoid a balloon where:
What happens when the balloon payment is due?
The balloon payment must be made as a lump sum upon the expiry of the car loan. There are typically a number of options available once the payment is due.
- The borrower can sell the car and use the money to make the payment and finalise the loan.
- The borrower can sell the car then choose to borrow again for a replacement car. If the original car is being traded in as a part of the payment for the new vehicle, the balloon payment can be included in the calculations for this to happen.
- If the borrower wants to keep the vehicle, they can roll over or refinance the payment into another loan.
Disadvantages of balloon payment car loans
Cost more in interest
As we've seen, car loans with balloon payments will see you pay more interest over the term of the loan.
Balloon shock
Some borrowers may not be prepared for the lump sum balloon payment even though they signed up for it at the outset and knew it was coming.
Many things can happen during the term of a car loan. If you're thinking of going down the balloon repayment route, you need to have a plan. You either have to be disciplined in budgeting for the final payment at the end or be prepared to sell the car in time to meet the final payment.
Savings.com.au’s two cents
Having a balloon on your car loan won't save you money because you'll pay a larger sum in interest across the life of the loan. However, it will provide you with the cash flow flexibility that lower monthly repayments can offer.
Anyone taking out a car loan with a balloon needs to plan ahead for how they will repay the lump sum at the end of the loan. There are a few options, and you'll need to decide on your strategy well before the final payment is due.
Balloon payments might suit you if you're looking to keep your regular loan repayments to a minimum or you're planning to turn over the vehicle at the end of the loan term.
However, it's best to avoid a car loan with a balloon payment if you struggle with budgeting or want to save on interest payments overall.
Balloon payments in business car loans
Because of the flexibility of smaller monthly repayments and the opportunity to replace fleet vehicles every three to five years, balloons are commonly found in business and commercial car financing. Reducing the monthly repayments on car loans can help businesses to manage cash flow more effectively, while the higher overall interest charges can be claimed as tax deductions.
If you’re interested in taking out a car loan balloon payment for business purposes, a tax accountant or financial adviser can advise on the best option for your business.
See also: Leasing vs buying a car for your business
Frequently Asked Questions
A car loan balloon payment typically ranges between 20-50% of the vehicle's purchase price. The most common range is between 30-50% which generally depends on the lender, the car type, and the loan term.
Yes, balloon payments significantly increase the total interest paid over the life of a car loan. By deferring repayment of a large portion of the principal until the end, you pay interest on a higher balance for a longer period compared to a wholly amortizing loan.
Yes, it is possible to refinance a balloon payment at the end of a car loan. It is one option to avoid paying the considerable lump sum, effectively allowing you to convert the remaining balance of your old loan into a new loan of smaller, regular payments. Bear in mind, this entails taking out another loan so you'll be up for more loan fees and you'll also be accruing further interest costs on the debt.
These are essentially the same thing - a large, lump sum due at the end of a car loan or car lease term. A 'balloon payment' is the term commonly applied to car loans while 'residual value' is the term used in car lease agreements.
Yes, balloon payments are particularly common with business car loans as they effectively lower regular repayments. This can alleviate pressure on business cash flows. Loans with balloon payments of 20-30% are frequently used in business and commercial vehicle financing.
Generally, you can’t get an extension on the due date of a balloon payment unless you refinance to a longer loan term or take out a new loan at the end of the term that allows the outstanding amount to be paid off in regular instalments.
If you can't make your final balloon payment, this counts as a default which could see your vehicle repossessed and also cause long-term damage to your credit score.
But there are common solutions to avoid this outcome, including refinancing your loan to pay the lump sum down gradually or selling the vehicle and using the money to pay off the balloon amount.
