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What is a Car Balloon Payment and How Does It Work?

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A balloon payment on a car is a final, lump sum paid at the end of a loan’s term that is larger than the payments that came before it. An auto balloon loan might be a good fit for those looking for lower monthly payments similar to a car lease but with the rights of ownership. It can be a smart idea if you absolutely know you’ll be able to cover the balloon payment, but it can be risky if you don’t have a plan for paying such a large amount.

What is a balloon payment on a car loan?

Auto balloon loans are more commonly offered by vehicle manufacturers, but banks, credit unions and other financial institutions may offer them as well. You may also find balloon loans for home mortgages and business purposes, such as commercial mortgages and equipment financing. A balloon payment on a car loan shares some similarities to a lease in that there are lower monthly payments and residual value at the end of the term, but there are some key differences as well.

In the case of a balloon loan for a car, the lender lays out a schedule of smaller monthly payments leading up to the balloon payment, also called the lump-sum payment. This amount is usually thousands or even tens of thousands of dollars, often around half of the car’s value. A car balloon loan can make sense if you’re looking for a lower monthly payment and have a plan for how you will handle the large balloon payment at the end of the loan.

EXAMPLE

Here is an example of a balloon loan in comparison to a traditional loan. Jane Smith is deciding between a 36-month balloon loan and a traditional 60-month auto loan for a new car that costs $42,950. In both cases, Jane makes the same 10% down payment and finances the same amount, but that’s where the similarities end. We’ll walk through the differences in APR, finance charges and payments below.

Balloon auto loan vs. Traditional auto loan

36-month balloon loan60-month traditional loan
Vehicle sale price$42,950$42,950
Down payment$4,295$4,295
Amount financed$36,655$36,655
APR6%5%
Finance charge$5,744$5,133
Number of payments35, plus final balloon payment60
Monthly payments$556.81$729.47
Balloon payment$24,911None

APR

Because balloon loans are generally riskier, the APR on a car balloon loan is typically slightly higher than on a traditional car loan. Therefore, finance charges will be slightly higher, too.

NUMBER OF PAYMENTS

The balloon payment could be due as the final payment within the loan term, or as a payoff after the loan term ends.

For example, in a 36-month loan, the balloon payment could be the 36th payment or the 37th payment after the full three-year term, depending on your contract. You may be able to find a longer or shorter term.

MONTHLY PAYMENTS

Lower monthly payments are the biggest advantage of balloon loans, but that doesn’t mean you’re paying less overall; it’s simply a different way to structure the loan.

BALLOON PAYMENT

This amount is set before you sign the loan contract and is determined based on the balloon factor, which is the estimated percentage of the vehicle’s value at the end of the loan term. For example, if a new car is worth $24,000 now and will be worth an estimated $15,000 in three years, then the balloon factor is 62.5%.

Balloon loans vs. leasing

Balloon loans are a bit of a compromise between leasing a car and traditional financing. Like leasing, balloon loans come with lower monthly payments, but they can get complicated, particularly if you’re not prepared to make that final payment. Leases typically offer the lowest monthly payments, followed by balloon loans and then traditional loans. So, if all you care about is the lowest possible monthly payment, you might want to consider leasing a vehicle.

One big difference between a balloon loan and a lease is the ownership of the car. With a lease, the dealer will own the car throughout the leasing period, but you may have the option to purchase the vehicle at the end of the lease. With a balloon loan, like with traditional financing, you would own the car when the loan is paid in full. Because of this, a balloon loan typically doesn’t come with mileage or other restrictions that are common when leasing a car.

Pros and cons of a balloon payment loan

If you’re looking for a lower monthly payment but don’t want to lease a car, you may be considering a balloon payment loan. However, it’s important that you have a plan to pay off the loan when it comes due at the end of the loan term.

ProsCons

  Smaller monthly payments

  Buys you time

  Very large payment at the end of the loan

  Danger of being upside down

  Higher interest rates and fees

Pros of balloon payment car loans

Smaller monthly payments: What’s not to like about that? If cash is tight, a balloon loan gives you the lower payments of a lease but the rights of ownership. Even if cash isn’t tight, small payments allow you to invest that cash in something with high returns, then turn around and apply those returns to the balloon payment.

Buys you time: If you don’t have the money to pay your car loan right now but are sure that you will have it by the end of the term, a balloon loan might be a good idea. Since you’ll know how much the balloon payment will be when you sign your loan paperwork, you’ll know how much you have to save for that final payment. In the meantime, those saved funds can be earning interest rather than going to a lender.

Cons of balloon payment car loans

Very large payment at the end of the loan: Unless you have superb budgeting skills or a unique financial situation, you may find yourself in an uncomfortable position at the end of the loan. Before you take out a balloon car loan, make sure that you have a plan for how you’re going to handle the balloon payment at the end of the loan.

Danger of being upside down: Since you’ll be making smaller monthly payments, you may not be keeping up with your car’s depreciation. This could mean that you owe more than the car is worth, which is called being upside down on your loan. By the time the balloon payment is due, you may be faced with having to pay more money than the car is worth or walk away from the car and risk damaging your credit.

Higher interest rates and fees: Since balloon auto loans are generally riskier than traditional financing, they often come with higher interest rates and fees. That’s something to keep in mind as you decide how you want to finance your next car. Even though your monthly payment may be lower, you could be paying more over the length of the loan.

Options at the end of a balloon loan

If you’re concerned about covering the large balloon payment, it’s important to understand your options at the end of a balloon loan. Here are a few of your choices when the balloon payment comes due.

  • Pay the balloon payment in cash: The simplest method (if you have the money) is to just pay the balloon payment to your lender. You’ll then own your car outright.
  • Sell the car: You could sell the car for enough to cover the amount you owe on it. If you financed your car through the manufacturer, you may have the option to sell it back, though you may be responsible for excessive wear, mileage and disposition fees. Depending on the car’s value and the payoff amount, you may walk away with some money in your pocket or have to cover the remainder out of pocket.
  • Trade in the car: Another option is to trade in your car and use the proceeds toward the purchase of a new car. You will be responsible for any shortfall of the car’s value, depending on how much you get for your car. Your lender may offer you the chance to roll any shortfall into your new loan, but that would almost certainly guarantee that you’d be upside down on your new loan.
  • Return the vehicle: Similar to selling your car or trading it in, you may be able to return the vehicle to the dealer where you bought it. This usually only works if you are also planning on buying or leasing a new car from this same dealer.
  • Consider refinancing: By refinancing your car’s balloon loan, a new lender puts a lien on the vehicle and pays off the old lender, giving you the ability to finish paying the car off over time. Be sure to run the numbers to determine whether refinancing your balloon loan makes financial sense.

Balloon payment loan: FAQ

Are balloon payment loans a good idea?

If you don’t have the money to put down right now but are confident that you will have the funds in a few years, a balloon payment loan can make sense. These loans combine the low monthly payments of a lease with actual car ownership. But they do come with risks — if you can’t make the balloon payment at the end of the loan, you’ll be put in a difficult financial spot.

What happens if I can’t afford the balloon payment?

If you can’t afford the balloon payment at the end of your car loan, you have a few options but none of them are ideal. You can try to sell your car to apply the proceeds to the balance that you owe. If you’re looking to buy a new or used car from the same dealer, they might allow you to return or trade in your car and apply the proceeds to your new loan. Another option to consider is refinancing your balloon payment with a new loan.

What is a typical balloon payment?

Like the residual value in an auto lease, the balloon payment at the end of a car loan depends on a few different factors. To get a rough idea, you can take the purchase price of the car plus any applicable taxes and fees, and subtract any down payment or principal amount you’ll pay over the course of the loan. The amount left will be your balloon payment, which will likely be thousands or tens of thousands of dollars. Luckily, your lender will disclose the amount of your balloon payment before you sign on the dotted line.

 

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