Essentially, a balloon payment allows you to pay less on your monthly installment because it is calculated on the loan amount only and doesn’t include that balloon payment. A balloon payment is in effect an inflation of your capital amount at a percentage (normally 30%) built as a final installment at the end of your finance period.
This leaves you with several options when your contract comes to an end: settle the balloon payment once and for all, re-finance the car, and sell it to cover the amount. “The long and short of it is that you end up paying a substantial amount more than what the car is actually worth with a balloon payment,” says Charl Potgieter, Head Absa Vehicle and Asset Finance, Personal Markets at Absa. “However, sometimes that is the only way you can afford to buy a car, which makes it a bit of a Catch 22.”
Where exactly does this leave you? What are your options when it comes to getting a car, and what should you know about the ins and outs of balloon payments? According to Potgieter, some important factors you should keep in mind are:
- Take a VW Polo Vivo, for example, a new Polo Vivo Trendline starts at a recommended price of R179 900. If you bought it on a 60 month finance term at a 10.5 percent interest rate, that would equal a monthly repayment of R3 867. The total payment for the car would be R232 005.
- Adding a balloon payment of 30 percent into the mix would mean that you would pay R3 179 every month – however, you would still owe R53 970 at the end of the contract. Overall, the total amount paid for the car would be R244 708.*
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- Bearing this in mind, you need to be brutally honest with yourself about whether you will be able to afford that additional payment at the end of your finance term. Think about how you will pay it off. What is the likelihood you will have an extra R53 970 just lying around gathering dust? If you think you would have to take out another loan to cover it, or re-finance or even sell your car, is it really worth it? If the answer to that question is no, then it’s probably not the solution for you.
- Calculate what you can afford without taking on a debilitating balloon payment. This might be the difference between choosing an entry level vehicle versus that dream car that makes your heart beat faster. However, future you, who’s not scrambling to find a huge sum of money to repay the balloon, will thank you for your prudence.
- Speak to a financial adviser or your Absa banker. They will help you find the best and most practical solution based on your financial reality, whether that is a more affordable car or longer finance term. Do, however, remember that a longer finance term means paying more interest.
“When choosing a car, think of it as a long-term commitment and focus on the benefits of making a decision that’s within your means: you get a much-needed car, and one that isn’t going to send you spiralling further into debt,” says Potgieter.