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What is a Car Balloon Payment and How Does It Work?
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A car balloon payment is a final, lump sum paid at the end of a loan’s term that is larger than the payments that came before it. Picture a balloon: a thin string leading up to a latex bag full of air. In the case of a balloon loan, the string is a series of small payments leading up to the hefty final payment.
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 have the ability to cover the balloon payment. It’s a risky idea if you don’t have a plan for plunking down that large amount.
- How a car balloon payment works
- Balloon loans vs. leasing
- Pros and cons of car balloon loans
- How to get balloon financing
How a car balloon payment works
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.
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 of dollars, typically around half of the car’s value.
Jane Smith is considering a 36-month balloon loan versus a traditional 60-month auto loan for a new car she wants to buy that costs $42,950. In either case, 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 Loan||60-Month Traditional Loan|
|Vehicle Sale Price||$42,950||$42,950|
|Number of Payments||35 plus final balloon payment||60|
Because balloon loans are generally riskier, the APR on a car balloon loan is typically slightly higher than that of 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. 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.
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.
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%.
How you make that final balloon payment is up to you:
- Pay it in cash.
- 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. If the car is worth more or less than the payoff value, you may walk away with some money in your pocket or you could have to cover the amount out of pocket if the difference isn’t in your favor.
- Trade in the car. Consider trading the car in for another vehicle.
- Return the vehicle. This allows you to walk away before paying the large balloon payment.
- Consider balloon 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. Here’s more on refinancing.
Balloon loans vs. leasing
Lower monthly payments, as we’ve already mentioned, are an advantage of balloon loans, but they can get complicated, particularly if you’re not prepared to make that final payment. If all you care about is the lowest possible monthly payment, take a look at vehicle leases.
Leases typically offer the lowest monthly payments, followed by balloon loans and then traditional loans. The difference between a balloon loan and a lease is that you would own your vehicle throughout the balloon loan.
What’s a balloon lease?
Technically a “balloon lease” doesn’t exist. The confusion could be due to the fact that balloon loans are often compared to leases. Both payment structures can be similar. In a car lease, payments are low for the first few years and at the end of the lease, the driver can choose to buy the car either in a lump sum payment, much like a balloon loan or through a lease buyout auto loan.
Pros and cons of car balloon loans
Smaller monthly payments
What’s not to like about that? If cash is tight, a balloon loan gives you lower payments similar to a lease but with 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.
Potential smaller tax burden compared with leasing
If you want to buy a vehicle you leased, the transaction usually counts as a taxable sale, an amount you would have to pay in addition to any taxes you may have paid during the lease. Depending on your state’s sales tax rules, all of this can add up. Of course, balloon financing means you paid sales tax upfront. Be sure to ask the dealer or lender about the tax implications of either scenario.
Ownership means no lease limits.
In most car leases, there are mileage limits and potential charges for extra wear and tear on a vehicle when you turn it in at the end of the lease. In a balloon loan, you own the car, so there are no such limits, assuming you plan to keep the car when the balloon payment is due.
Size of the balloon payment
The closer you get to the balloon payment date, it may start to look less like a small county fair balloon and more like a giant one from the Macy’s Thanksgiving Day Parade. You might not have thousands of dollars on hand when the time comes.
Danger of an upside down balloon
While this might conjure an amusing mental image, it can be a multi-thousand dollar risk where your car balloon payment is more than what the car is worth, leaving you upside down on your car.
A car’s balloon loan payment is set at the beginning of the loan and does not change. It’s based on estimates of time and miles, such as three years and 36,000 miles. However those things are estimates. If you put 100,000 miles on the car in that time, it’s going to be worth much less than if it had 36,000 miles.
This may be a problem if:
- You planned to sell the car to cover the balloon payment. It might not sell for as much as you owe, leaving you paying the difference out of pocket.
- You planned to refinance the balloon loan. It might be more difficult to find an affordable refinance loan.
- You planned to trade in the car. You may have to roll over the negative equity into your next car deal.
No refinance guarantee
There is no guarantee that you could refinance the car at the end of the balloon loan period, especially if your financial situation has changed.
How to get balloon financing
Check that the lender you want to use offers balloon loans in your state. Balloon loans are not always available, depending on the state and the lender. For example, Lexus Financial Services offers balloon loans only in Arkansas, Georgia and Illinois.
1. Choose the vehicle.
Ask the lender representative, which may be the car salesperson in the case of manufacturer financing, what vehicles qualify for a balloon loan. Not every vehicle may be eligible.
2. Negotiate the price.
Before you talk about any type of financing, you need to know how much you’re paying. Negotiate the price of the vehicle and your trade-in, if you have one.
3. Look at all loan options.
Consider how long of a balloon loan you want and see if any traditional financing or lease options might be a better fit. It’s always smart to go to a dealership with an auto loan preapproval in your pocket so you know what APR you deserve.
4. Choose and sign.
Pick the financing option that’s best for you and sign!