Motoring

A short-term gain but a more expensive car at the end of your loan term, here’s why a balloon payment is a big no-no

Say you’re interested in a car that costs about R200 000. If you elect to take a 25% balloon payment on the loan, you’ll be paying back only R150 000 over five years. This means your instalment will be lower. But, when that initial loan term ends, you’ll still owe the 25%, which works out to R50 000.

“Remember, having a balloon payment means you have an additional debt which you are not paying off, but you’re paying interest on it over the full loan term,” motoring website Drive It, explains.

Head of 1st for Women Insurance Seugnette van Wyngaard helps us understand the technicalities of balloon payments:

What is a balloon payment?

It’s a lump sum that’s due to a financier, e.g. the bank, at the end of a loan term. This allows you to pay only a portion of the price of a car. The remaining amount is due at the end of that initial loan term. It can be paid off in cash or refinanced, subject to credit approval. What balloon payments do is lower your monthly car repayments. But, you only become the owner of the car once the initial loan amount and the residual value has been settled.

How do banks determine who qualifies for this payment option?

Standard instalment sales, balloon purchases, as well as leases are subject to you meeting the affordability criteria. Although certain financiers are willing to assist those with a less than ideal credit score, a good credit score will not only help you to secure a loan more easily, but also to do so at a more favourable interest rate.

Why are balloon payments discouraged?

You end up paying significantly more for the same car due to interest charges. If you want to own the car, you’ll become responsible for the residual amount at the end of your loan agreement. Refinancing this amount will incur additional charges and even more interest. It’s definitely not an ideal situation.

How can you avoid a residual payment altogether?

‘Buy what you can afford and rather pay a deposit than a balloon payment’ is a good rule of thumb. Purchase a car you can afford through a normal instalment sale. Saving up a healthy deposit and structuring your repayments over a shorter term could save you thousands of rands. There’s no way to really “avoid” a balloon payment once an agreement with a financier is in place. Balloon payments can be paid off early even though a penalty fee may apply, but it’s best to read your contract for any restrictions.