If your broker suggests an offer from a lender that has a ‘residual value’ or ‘balloon’ payment as part of the loan contract, this means that in return for making reduced payments throughout the loan term, there is a lump sum payment due at the end of the loan contract.
Balloon payments can have advantages and disadvantages, depending on your circumstances. Check out the information below as we investigate the ins and outs of balloon payments.
Important points
- If you are financing a car for business, a balloon payment can help you to maintain your cash flow throughout the loan term, allowing you to grow and invest in your business
- The repayments are reduced because you pay less of the principal loan amount during the loan term. This amount is offset by the balloon payment at the end of the loan term
- You can sell the car at the end of the loan term to cover the balloon payment or refinance to take out another loan to cover it, among other options
- The balloon amount is expressed either as a percentage of the principal loan amount, or as a dollar value amount.
How much will the final vehicle balloon payment be?
The balloon amount is expressed either as a percentage of the principal loan amount, or as a dollar value amount.
There are fixed minimum payments for all Lease car financing options – if you are considering a Chattel Mortgage, Finance Lease, Novated Lease, Fully Maintained Lease or Commercial Hire Purchase, the minimum amount of the balloon payment is set by the Australian Tax Office:
| ATO Minimum Residual Value Guidelines | |||
| Length of Lease | 3 | 4 | 5 |
| Minimum Residual Value (% of principal) | 46.88% | 37.5% | 28.13% |
Advantages of a loan with a balloon payment
Put savings into something that might grow over time
A huge reason why many people prefer a balloon payment is that they can put their savings into something that will (hopefully) grow over the loan term.
For example, if someone saves up $10,000 and uses it as a deposit for a car, that money is tied up in the vehicle and, like almost all cars, will depreciate over time.
However, if some uses that same saved $10,000 and puts it into an investment (eg. stocks) and leaves it during the loan term (eg. 5 years), hopefully it’ll grow and cover the balloon payment.
Another option is to of course leave the money in a savings account for emergencies.
Whatever your decision, make sure to factor in your circumstances and needs and, even better, talk to a professional.
Keep your money where it matters
Reduced repayments mean you have more cash on hand each pay cycle. Many people are attracted to balloon payments because they reduce how much you need to pay back each week.
Increase lender confidence
Put yourself in a good position for future loans by proving that you can make a lump sum payment after building equity in your loan with regular, on-time payments. This can really make a difference down the track and help improve your credit score.
Increased maximum loan amount
When you buy a car with a car loan and balloon payment, you might be able to finance a top-end or newer vehicle rather than an older, base model. This is because balloon payments reduce your regular repayments meaning you have more capacity to pay back a larger amount.
No requirement for up-front equity
You won’t need to have a large deposit to buy the car that you are looking to finance.
When are balloon payments used?
Balloon payments are commonly used in the following types of loans:
Chattel Mortgage
*A Chattel Mortgage is similar to a car loan, but usually for businesses, rather than private citizens
- This loan is the most frequently used when the vehicle is primarily for business use
- No deposit is needed
- The lender (e.g., a bank) advances the full sum of the car price meaning the client can take full ownership of the chattel mortgage vehicle upon purchase. This means the business can claim the full amount of the GST as an input tax credit in the same financial year
- The client has a contract to pay the lender the agreed amount in regular instalments
- There is often a balloon or residual payment at the end of the term
Novated lease
- A novated car lease is an agreement between an employer, employee and their finance company (3 parties rather than a borrower and a lender like with a regular car loan)
- It is often referred to as purchasing a car through ‘salary sacrifice’
- Despite the “lease” part, the vehicle belongs 100% to you, the employee, and you have complete choice over which vehicle you purchase
- Your employer makes payments to the finance company from your pre-taxed income (ie. before it’s gone into your bank account)
- There can be a balloon payment at the end of the loan term. This is the only payment which GST will apply to, saving you up to $5,000 on the total value of the car
- Using a novated lease calculator you can work out what your repayments will be and how long you’ll have the lease for
Finance Lease
- Used by corporations, partnerships, sole-traders – most suitable when you need the vehicle to make an income (eg. a truck)
- Flexibility to change the vehicle when your requirements change
- The lender purchases the car on your behalf, and you pay a fixed monthly payment to use the car for the duration of the contract
- At the end of the lease, you have the option to pay the residual value and take clear title (full ownership) of the car
Fully maintained Lease
- This is the same as a novated lease, but the monthly payments also include vehicle running expenses, including petrol, registration, insurance and maintenance
Commercial Hire Purchase
- Similar to a finance lease, the only difference is the option for a deposit at the beginning of the contract. This can be cash or a trade-in
- At the end of the contract, the lessor can pay a residual amount and take ownership of the vehicle
Who is a balloon payment suitable for?
The Smart Saver
If you habitually save for a rainy day by putting away a few dollars every week, you’ll easily save the amount you need for the final big payment.
The Savvy Investor
A balloon payment is for you if you are a savvy investor who uses their capital to earn before your debts are paid off.
The Happy Beneficiary
If you are certain that you will receive a lump sum payment that will cover the balloon and will be paid before the end of the loan contract, this type of loan might be suitable for you.
What happens when the contract is up?
There are several options at the end of a loan that has a balloon payment attached. To explore these, let’s see what happened to our 3 loan recipients above:
| Case Study 1: Jane The Smart Saver |
|---|
Jane has diligently put away 15% into a separate savings account each week over the last 3 years, and when she reaches the end of the loan, she has more than enough to make the final payment on her Mazda 3. However, her daughter, who moved to Canada last year, is having a baby, and Jane decides that she would rather spend the money taking a trip to see her daughter and new granddaughter Jane speaks to her finance broker, who arranges to refinance, rolling the balloon payment into a continuing loan until the final sum is paid. |
| Options available to Jane: Use her savings to pay her balloon payment refinance to repay the balloon slowly over time |
| Case Study 2: Josh, The Savvy Investor |
|---|
Josh, the Savvy Investor, has managed to use the money saved on repayments to invest in marketing strategies to grow his kitchen showroom and generate more business. After speaking to his accountant and to his finance broker, he decides that he can afford a vehicle upgrade. He also used some of his savings for investments instead of a deposit. When Josh signed up for his novated lease (which had a balloon payment), he invested some savings into ASX shares and cryptocurrency. After his 5-year loan term, these investments had grown considerably. Josh trades in the ute he bought with the first loan. The trade in covers the value of the balloon payment, and his broker arranges a new loan contract for the new car. |
| Options available to Josh: – Sell the shares / crypto currency and use that to pay the balloon payment – Trade in the car he originally bought with his novated lease and use those funds to pay the balloon payment |
| Case Study 3: Julie’s Getting An Inheritance |
|---|
Julie, the Happy Beneficiary, was delighted that her Grandfather left his Audi to her in his will, in addition to the sum of money that she expected. No longer needing the Toyota Yaris that she bought with the car loan, at the end of the loan contract she pays the $5000 owing on the car in cash, finalising the loan. She decides to keep the Yaris for her son to learn to drive in. |
| Options available to Julie: – Use funds received from a third party during the loan term to pay off the balloon payment |
Balloon payments in summary
Like all options for financial products, make sure to compare balloon payments to your needs and circumstances – what worked for your friend, might not work for you and vice versa.
A finance broker can use their skill and experience to identify which type of loan would best support your business, commercial and individual needs. A broker will help you to select the loan option with the best tax benefits, saving you money.
Of course, we are here to help and match you and your needs to the right tailored product every time.
