Balloon Payment Explained

Published by
Lethabo Ntsoane

A balloon payment is an amount of money that is paid at the end of a loan term. A balloon payment is popular in the motor vehicle finance industry where expensive motor vehicles are sold with low instalments and a balloon payment to attract customers. 

What is a Balloon Payment?

A Balloon Payment is a lump sum that is paid at the end of a Balloon Loan. A balloon loan is a loan that doesn’t fully amortise over a loan period, requiring a lump sum (Balloon Payment) to be paid at the end of the loan period. The loan will have equal instalments with a lump sum payment, rather than paying equal instalments throughout the loan period to cover the sum of a loan.

 The purpose of this payment is to make loan repayment more affordable, to pay it in a shorter period of time, and to pay an outstanding amount as a lump sum at the end of the loan period. A loan with a balloon payment is repaid fully much faster than a standard loan. However, the balloon payment requires a lump sum payment and money may not be available to cover the shortfall. 

Characteristics of a Balloon Payment

  • They are mostly applied to motor vehicle loans in South Africa.
  • It is a lump sum that is paid at the end of a loan period.
  • They are typically 35% of the total debt value.
  • Balloon loans have high-interest rates causing balloon payment to incur high interest rates on the due date.
  • It offers borrowers a way to repay loans in a short period while paying low installments.

How Balloon Payment Works

A balloon payment is normally charged at 10% – 35% to the value of the loan amount due. The amount will be paid at the end of the loan period which is shorter than the standard loan period for the asset purchased on finance. 

The borrower may trade in the asset to make the payments or seek other repayment options available. Trade-in value of an asset is sometimes guaranteed by lenders or asset sellers. 

What options do you have when a Balloon Payment is due?

There are several things that you can do when a balloon payment is due. When applying for a loan that has a balloon payment, you can make use of the following options that are available to you. 

Paying off the Balloon Payment

Balloon Payment has to be paid when due and the easiest way when you have a sum due is to make the payment yourself. You can plan to do this when you first take out a loan that requires a balloon payment. You can open a savings account and start saving, withdraw funds from a trust fund or other investments that are secure, alternatively, you can sell an existing asset to cover the amount owed. 

Refinancing the Asset

Not everyone has enough money to make this payment since the lump sum needed will be high. One can refinance their existing loan through a new loan. The refinance loan can be issued to make a balloon payment. 

A refinance loan comes with many benefits and the three most important are the optimisation of the new loan term, setting a new interest rate, and the optimisation of installments of a new loan. A refinance loan may require adding the asset finances as collateral. 

Not everyone can get a refinance loan. This loan is only available to those with a good credit score and with enough income to cope with the new debt. Therefore, if your credit score and income suffer as a result of your Balloon Loan, you will be rejected for a refinance loan. 

Work on your credit score and make sure that your income is enough so that you can afford the new loan. Make sure you stay up to date with your loan payments and track your credit score during your balloon loan. 

Trade the Asset

Another way to cover the balloon payment due is to sell the asset. The proceeds from the sale of an asset will be used to pay the debt. However, the proceeds from the sale of an asset do not always cover the entire payment owed. In this case, the borrower will have to pay the outstanding amount that is due. 

A shortfall from a sale of an asset to pay off a balloon payment may happen because of the wear and tear of an asset or a market drop in the price of an asset being sold. Balloon loans are more beneficial to those buying assets that appreciate in value over time such as collectible assets. 

Advantages

  • Deposit is usually not required.
  • Borrowers are able to save money while driving a financed vehicle or using an asset bought with a balloon loan.
  • Allows the borrower to set aside money or leverage future income immediately.
  • The repayment period is relatively short.
  • There are options to finance this kind of loan payment if there isn’t enough money to cover the amount due.

Disadvantages

  • When compared to standard loans of the same duration, the interest rate is high.
  • The decline in the demand for the financed asset can cause the asset’s value to be lower than the balloon payment due.

Conclusion

Balloon Payment provides customers with financial leverage to benefit from their future situations in the present. A balloon loan is only issued to qualifying clients, therefore, one cannot get a balloon loan just because they are expecting future financial inflow. Current income and credit record will have to show that you can manage to repay monthly installments. 

Lethabo Ntsoane

Lethabo Ntsoane holds a Bachelors Degree in Accounting from the University of South Africa. He is a Financial Product commentator at Rateweb. He is an expect financial product analyst with years of experience in reviewing products and offering commentary. Lethabo majors in financial news, reviews and financial tips. He can be contacted at lethabo@rateweb.co.za

Published by
Lethabo Ntsoane