Popular among auto loans, balloon loans provide a means to finance an asset with minimal monthly payments. The majority of these loans are issued by major banks. Balloon loans are meant to be repaid in a shorter amount of time than ordinary standard loans. For instance, a balloon loan on motor vehicles will have a 48-month repayment duration as opposed to 72 months.
What is a Balloon Loan?
A balloon loan is one that is not completely repaid over the loan’s term. Rather than paying the full amount over the loan time, it demands a set payment at the conclusion of the loan period to cover the outstanding principal balance of the loan.
Balloon loans are intended to endure for a shorter period of time and have a shorter repayment period than a conventional loan. Many people like the loan since it has fewer monthly payments than a traditional loan because a portion is paid in a single lump amount at the conclusion of the loan period.
Characteristics of a Balloon Loan
- They have a shorter payment term than standard loans.
- Loans incur slightly higher interest payments during the loan period when compared to standard loans.
- The loan requires a lump sum payment at the end of the loan period.
- At the end of the loan period, banks or lenders give options to finance balloon payments.
How a Balloon Loan Works
A balloon loan consists of two components: monthly payments and a balloon payment. When you obtain a balloon loan, you will be expected to make regular loan payments in addition to a balloon payment at the conclusion of the loan period. This payment is a lump sum agreed upon by the lender and borrower at the beginning of the loan’s term.
For instance, you can obtain a balloon loan to purchase a R500,000.00 automobile with monthly payments of R10,000.00 at 6.69% interest compounded monthly for 48 months. The balloon loan will require a balloon payment of R114,310.00 upon amortisation. Consequently, the total amount payable through amortisation is R584,310.00.
The difference between a conventional loan and a balloon loan is that a conventional loan requires a monthly payment of around R12,120 with no additional payment due at the conclusion of the loan period. However, a balloon loan will necessitate minimal monthly payments because a balloon payment is due at the end of the loan term to offset the shortfall.
A balloon loan has a higher interest rate than a conventional loan. The loan’s balloon payment accrues interest over 48 months, but the normal loan does not. Consequently, the conventional loan will accrue R81,760.00 in interest, but the balloon loan will accrue R84,310.00 in interest for a 48-month loan at a 6.69 percent interest rate on an R500,000.00 vehicle.
What are Balloon loans used for?
Balloon loans can be used for business and personal financing purposes. These are the use of balloon loans.
Balloon loans are most commonly used in South Africa to finance a vehicle. Balloon loans require a balloon payment of up to 35% at the conclusion of the loan term. Normally, these loans are repaid in 48 months.
Building and vacant land financing
Building loans and land loans can be converted into balloon loans upon request. These loans will normally allow you to pay reduced installments and pay a lump sum at the end of the loan period.
Balloon loans are useful when buying a home. Home loans take forever to pay off, however, with a balloon loan you won’t have to pay off your home loan in a 20 – 30 year period. Instead, you will repay your home loan earlier but this will be subject to your income.
Businesses have projects that run for years and in some cases decades, therefore, lenders understand that giving businesses balloon loans is crucial. Balloon loans help businesses meet their short-term obligations, in turn, businesses are able to accelerate loan repayments on loans over time when projects become successful.
Advantages of Balloon Loans
- Monthly repayment on loans are lower than that of traditional amortised loans. This is attributed to the low principal being paid instead of the whole loan amount during the stipulated period.
- Balloon loans are available for different uses and for juristic or natural persons.
- Amortization of the loan is shorter than traditional amortised loans.
- Borrowers can refinance balloon payment due at the end of the loan term.
Disadvantages of Balloon Loans
- Borrowers need to pay a high percentage of the loan amount at the end of the loan term. Those with low credit scores will have difficulties refinancing their balloon payment.
- The interest rate on the loan is high.
- The trade-in value of the asset can be lower than the balloon payment required, therefore, a cash injection from the borrower to cover the outstanding balloon payment amount will be required.
Balloon loans are a great option to acquire assets that are of high value. The borrower of a balloon loan doesn’t risk being over-indebted during the loan period. The loan is beneficial to those that are expecting money in the near future from an investment or from trust fund interest allotments. Money expected for the aforementioned investment vehicles can be easily used to cover the balloon payment due at the end of the balloon loan’s term.