What is a car loan balloon payment and how does it work?

author-avatar By on June 29,2018
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What is a car loan balloon payment and how does it work?

Learn exactly what a car loan balloon payment is and how it could affect the cost of your car loan.

What is a balloon payment on a car loan?

A balloon payment or “residual value” is an agreed-upon lump sum that you will pay to your lender at the end of the car loan term. Effectively, the balloon amount builds over the period of the loan by diverting a portion of your interest payments into it, so that your monthly payments (from a cash perspective) are reduced. Balloons are usually a significant lump of your loan amount (eg. 30-50%), which is why they have the ability to reduce the amount of your monthly repayments in such a substantial way.

Fixed rate car loans for new cars

Provider
Ad rate
p.a.
Comp rate*
p.a.
Monthly
repayment
 
5.45% 5.80% $572 More details
from 6.99% from 8.05% from $594 More details

Data accurate as at 17 March 2020. Rates based on a loan of $30,000 for a five-year loan term. Products sorted by advertised rate, then by company name (A-Z). View disclaimer.

How to calculate a balloon payment

Example: If Daniel took out a $30,000 car loan for 5 years at 6% interest and had a (30%) balloon of $9,000, his monthly payments would be reduced from $579.98 (no balloon) down to $451. At the end of the loan term, he would then have to pay the $9,000 sum leftover in full.

It’s important to remember that while car loan balloon payments are helpful because they reduce your monthly repayments, they do in effect charge you more in interest across the term of the loan. Looking at Daniel’s case a little closer, we see that with a 30% balloon, Daniel’s interest costs are $1,260 more.

Cost of a $30,000 5 Year Car Loan at 6% Interest Rate (Excl. fees) 30% Balloon No Balloon
Monthly Repayments $450.99 $579.98
Total Repayment after 5 years (Repayments + Balloon) $36,059.40 $34,798.80
Interest Costs $6,059.40 $4,798.80
Cost Difference +$1,260.20

Source: Savings.com.au Car Loan Calculator

Why you might consider a car loan balloon payment

There are a number of reasons why someone might consider having a balloon payment on their car loan. The first is that the repayments are less per month when compared to a car loan with no balloon. This provides a lot more cash flexibility, particularly for people who may have other expenses to pay (or less income coming in) for the period of the loan. It can also have the added benefits of qualifying for a larger car loan amount.

A lot of people also consider car loan balloons because there is an option for them to trade in their car at the end of the term and use the proceeds to pay off the balloon. They can then apply for a new car loan to fund the purchasing of a replacement vehicle. This is quite common for business car loans.

What happens when the balloon payment is due?

The balloon payment must be made as a lump sum once the car loan has expired. There are typically a number of options available once the payment is due.

  • If the borrower wants a new vehicle, they can sell the car and use the money to make the payment and finalise the loan. The borrower is then entitled to buy a replacement car and if they wish, apply for a new car loan to pay for the replacement vehicle. If the car is being traded in as a part of the payment for the new vehicle then the Balloon Payment can be included in this process.
  • If the borrower wants to keep the vehicle, they can make the payment in cash, roll over or refinance the payment into another loan.

FAQs

Can you refinance the balloon payment on a car?

At the end of a car loan, you could refinance the balloon payment to be paid off gradually, rather than in a lump sum. Bear in mind that this could be like taking out another loan, so you may accrue interest costs on this debt. In general, the longer the loan term you refinance this debt at, the more interest you could end up paying.

How to extend a balloon payment?

Generally, you can’t get an extension on the due date of a balloon payment unless you refinance to a longer loan term or into a new loan at the end of the loan term to be paid off gradually.

Balloon payments in business car loans

Because of the flexibility of smaller monthly repayments and the opportunity to replace your car every three to five years, balloons are commonly found in car loans for business and commercial purposes. Reducing the monthly repayments on a car loan can help a business to manage its short-term cash flow more effectively, while the higher interest rate charges can be claimed as a tax deduction.

If you’re interested in taking out a car loan balloon payment for business purposes, it’s a good idea to consult a tax accountant or financial adviser to find out how it could benefit your business.

Savings.com.au’s two cents

Having a balloon on your car loan will not save you money, because you will have to pay a higher amount of interest across the life of the loan. However, it will provide you with the great flexibility of lower monthly repayments.

Remember though that while it will help you save on your outgoing expenses during the term of the loan, there’s a lump sum that needs to be paid at the end of the loan. Make sure to shop around for a low interest rate before making a purchase decision and calculate your possible monthly repayments in advance using a car loan repayment calculator.


Disclaimers

The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:

  • The big four banks are: ANZ, CBA, NAB and Westpac
  • The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2019. They are (in descending order): Credit Union Australia, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
  • The larger non-bank lenders are those who (in 2019) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.

Some providers' products may not be available in all states.

In the interests of full disclosure, Savings.com.au and loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.

*The Comparison rate is based on a $30,000 loan over 5 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate.

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Dominic Beattie is the Editor of Savings.com.au. He has been publishing articles on finance, business and economics since 2015, having previously worked as a Senior Journalist at financial research firm Canstar before helping to launch Savings.com.au in November 2018. Dominic aspires to help everyday Australians discover simple and effective ways to comfortably manage their finances and save money, without sacrificing their joie de vivre.

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