When you’re in the market to buy a car, a balloon, or residual payment might seem like an attractive option as it means you will pay a much lower monthly instalment. What you might not realise is that taking a balloon payment actually increases the total cost of your car finance. It gets worse. The car isn’t yours until you settle the amount at the end of the finance term… which you have to pay in a large lump sum. Ouch!
How does it work?
Balloon payments are usually between 5% and 60% of the total purchase price of a car and can be structured for the finance term of between 12 and 72 months.
Let’s say you’ve found a car you like for R200,000. You opt for a 30% balloon payment, which means your monthly instalments are calculated on R140,000. At a 12% interest rate over 60 months, you’ll pay around R3810.08 per month. That means that the total amount you’re paying for the car is about R230,000 – that’s R30,000 more than the original price PLUS you still owe R60,000 in cash. So your car, which you thought cost R200,000, has actually cost you almost R100,000 more.
What if you already have a balloon?
If you want to own the car at the end of your finance term, there’s no easy way around it: you have to save enough money each month to be able to pay the final lump sum at the end. If you cannot come up with the balloon payment, you may end up financing your car for two or three more years, which further increases the costs. You could also ask your bank if you can pay in an additional amount each month towards settling the balloon payment.
The bottom line
Six years is a long time, and it’s easy to forget about the looming balloon payment. Depending on your finance agreement, if you can’t afford to pay the lump sum (or you can’t refinance the vehicle), you could end up facing some distressing debt.
If you are buying a car to own it by paying it off altogether, instead choose a model that you can afford without a balloon payment at the end.