Getting an auto loan can be a hassle at times! Even if you get one, your next concern will be making the payments on this loan. So, a balloon loan may be a good option if making payments on a standard auto loan worries you. But actually, what is a balloon loan? Keep reading to know in detail about a car loan with balloon payment!
What is a balloon loan?
A loan that does not fully repay during its tenure is called a balloon loan. A balloon payment is a good auto financing choice if you want to purchase a new car. Since not fully amortized, a balloon payment is necessary to pay off the loan’s remaining principal balance at the end of the period. So you’ll need to start saving money at the beginning of the loan period to get ready for the biggest payment at the end!
As it often have lower interest rates than loans with longer periods, they can appeal to short-term borrowers. However, the borrower must consider the risk that the loan would reset at a higher interest rate when refinancing. In addition, the impacts could be severe if you cannot make the final payment and pop the balloon at the end of the tenure.
How a balloon loan works
With a balloon loan, you need to pay lower monthly payments in return for a single huge payment at the end of the loan period. Therefore, you can consider a it as an alternative to a conventional car loan.
The loans that are most frequently associated with balloon payments are mortgages. A car loan with balloon payment typically ranges from 5-7 years. However, the short-term monthly payments don’t cover the total loan payback. However, a it has an extremely different payment schedule than a regular loan. It is because the borrower has paid off only a part of the principal balance after the 5-7 term; the remaining balance is payable all at once.
Example of a balloon loan
Imagine you take a loan of $200,000 with a seven-year term and a 4.5% interest rate. Your monthly payment will be around $1,013 every month for seven years. But at the end of the period, you must pay a balloon payment of $175,066.
What is a balloon payment on a car loan?
Automobile manufacturers are more likely to offer auto balloon loans. Still, banks, credit unions, and other financial organizations may offer it. There are some important differences between a lease and a balloon payment on a vehicle loan. However, both have lower monthly payments and residual values at the end of the term.
When you take one for your car, the lender establishes a plan of smaller monthly payments leading up to the balloon payment, also known as the lump-sum payment. This sum is typically in the thousands or tens of thousands of dollars, or around half the vehicle’s worth. Therefore, a car balloon loan can be useful if you’re looking for a reduced monthly payment and have a plan for handling the significant payment at the end of the tenure.
Balloon auto loan vs. Traditional auto loan
Along with knowing the loan, you should also understand the difference between it from a standard auto loan.
You’ll have to make monthly payments to cover the debt and interest if you use a standard auto loan to buy your car. You will make the same monthly payment until the entire principal and interest get repaid. The amount you pay monthly depends on the loan amount, interest rate, and loan period.
The small monthly payment you’ll have to make on a balloon loan is its highlight. But the interest rate can be larger than a standard auto loan. Also, you’ll have to pay a sizable lump sum as your final payment. The balloon payment amount varies, although the manufacturer’s suggested retail price (MSRP) of the car determines it.
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Loan Comparison
| 36-month balloon loan | 60-month standard loan | |
| Vehicle selling price | $42,950 | $42,950 |
| Down payment | $4,295 | $4,295 |
| Amount financed | $36,655 | $36,655 |
| APR | 6% | 5% |
| Finance charge | $5,744 | $5,133 |
| Number of payments | 35, plus the final balloon payment | 60 |
| Monthly payments | $556.81 | $729.47 |
| Balloon payment | $24,911 | None |
What to note
APR: The APR on a car balloon loan is often slightly higher than on a standard auto loan because balloon loans are frequently riskier.
Monthly payments: The balloon payment will be the last payment made during the loan period or as a lump sum payment after the term has expired. Depending on your plan, the balloon payment in a 36-month loan can occur at the 36th or 37th payment following the term. There can be a longer or shorter term available.
The number of payments: Balloon loans have lower monthly payments, but this doesn’t guarantee you’ll pay less overall.
Balloon payment: This loan amount is established based on the balloon factor. For instance, the balloon factor will be 62.5% if a new car costs $24,000 today and can expect to be worth $15,000 in three years.
Balloon loans vs. leasing
Balloon loans have lesser monthly payments than leasing does. But they might be challenging, especially if you’re not ready to make the final payment. Leases often offer the lowest monthly payments. Therefore, you might want to consider leasing a car if all that matters to you is making the smallest monthly payment. The ownership of the vehicle is one significant distinction between it and a lease. In a lease, the dealer retains ownership of the vehicle for the duration of the lease; however, you can have the option to purchase the vehicle. You become the vehicle owner when you repay a balloon loan. As a result, a balloon loan frequently has no limitations, which is usual while leasing a car.
Pros and cons of balloon loans
Pros
- Smaller monthly payments: A balloon loan can be an option if you still want to own a car but have trouble making payments on a standard auto loan.
- No down payment: A down payment is one factor that prevents many from buying a car. Some lenders don’t demand a down payment for balloon loans.
Cons
- Not common: It’s harder to find a lender for a car balloon loan than it is for a regular loan or lease. For instance, credit unions are not as likely to have them.
- Higher interest rates: Since auto balloon loans are considered riskier than typical car loans, some lenders will charge you higher interest rates.
- Slow down on equity growth: With a balloon loan, you won’t own as much of your car when you’re nearing your final few payments. It is because it do not include amortization in their calculations, but standard loans do.
- Large lump sum payment: The biggest disadvantage with balloon auto loans is the hefty payment at the end. Depending on the balloon factor your lender chooses, you might be paying a significant portion of the car’s value in one lump sum.
Dangers of auto balloon loans
The biggest danger will be failing to cover the last payment. It can adversely affect your credit score. You might not be eligible for refinancing if your credit worsened after you took out the loan. Even if you are, refinancing involves taking on more debt. It also carries a substantial danger of leaving you with an upside-down car loan, which is more than the value of your vehicle. You will be upside down and unable to sell, trade-in, or refinance your car if the value of your vehicle drops over the term of the loan.
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Options at the end of a balloon loan
Pay the balloon payment in cash: The best approach is to pay your lender the balloon payment. After that, your car will be fully yours.
Sell the car: You might be able to repay your debt via the vehicle’s sale. For instance, you might be able to sell it back if you financed it through the manufacturer.
Trade in the car: Another choice is to sell your vehicle and put the money toward the cost of a new vehicle. You will be liable for any value deficit depending on how much you receive for your car.
Consider refinancing: It results in a lien being placed on the vehicle and pays off the previous lender. And you can pay the car off over time.
Return the vehicle: You might be able to return the car to the dealer where you purchased it, like when you sell or trade in your car.
The bottom line
- It is a great financing option if you’re purchasing a new vehicle.
- You’ll have lower monthly payments.
- You may not also need to pay a down payment for getting one.
FAQs
Are balloon payment loans a good idea?
It can be useful if you don’t have the down payment money now but are sure you will have the money in a few years. These loans combine actual car ownership with low monthly payments of a lease.
What happens if I can’t afford the balloon payment?
One option is to sell your car and use the money to pay down the balance amount. They will let you return or trade in your vehicle and invest the money towards your new loan if you want to purchase a new or secondhand car from the same dealer. The refinancing of your balloon payment with a new loan is another choice.
Can you refinance an auto balloon loan?
Yes. Refinancing extends your repayment duration by an additional 5-7 years.
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