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How to use balloon payments to your advantage

There’s a misunderstanding that a balloon payment makes a car cheaper.
Image: Patrick T Fallon, Bloomberg

Factoring a balloon payment into the finance agreement of your next car purchase may come with some appealing benefits, but make sure these benefits are understood clearly and used wisely. Responsible budgeting is key with such payments, so you’ll need to act sensibly during the term period to maximise what they offer.

A balloon payment allows a buyer to take an amount owing on the purchase price of a car and set it aside, meaning the monthly instalment amounts are calculated on a lower value – in turn making repayments more affordable. You’re essentially paying off a loan for most of the car, but not all of it. The amount set aside at the outset remains the buyer’s responsibility and will still need to be settled in the long run.

There’s a deep-seated misunderstanding among consumers that a balloon payment makes a car cheaper, or it allows them to drive a vehicle they simply cannot afford. However, this is not what a balloon payment is designed for. This type of payment is intended to assist with cash flow management at the start of a finance agreement, but only if you can afford it. It may help to ease the burden of monthly expenses, but buyers with balloon deals may need to use cash they’ve been saving to settle the balance owed at the end of term.

Depending on the percentage of the balloon amount, the money saved on monthly payments should more than cover the costs of interest for a loan in order to refinance the lump sum of debt at the end of a balloon term.

In other words, it could be more prudent to save the money yourself while driving the financed vehicle than it would be to apply for another bank loan to settle the outstanding amount owing on the vehicle after years of driving it.

Vehicle owners entering into a balloon payment deal should familiarise themselves with the term ‘breakeven point’. The breakeven point occurs when the financed car’s trade-in value matches the amount still owed to the bank. When calculating the breakeven point, it’s important to include the amount outstanding in the balloon debt at the end of the loan period.

The reason a breakeven point is so important to understand is that South Africans have a tendency to change or upgrade vehicles more often than is financially viable. The breakeven point on a vehicle financed with a balloon payment is further down the line than it would be with a conventional instalment deal. If your breakeven point comes at 36 months, but you simply cannot resist a shiny new car after only two years, the amount owed on your first car will be added to the cost of the new deal.

As such, you’re still paying off a portion of your old car while driving your new one. Consumers who do this multiple times could find themselves in financial trouble if, for example, there is a change to their income and financial situation, resulting in outstanding debt becoming unmanageable. This is a dangerous trap to fall into, and we strongly advise our customers to consider changing cars only once the respective breakeven point has been reached. This will keep monthly repayments, the value of their current car, and the balloon debt evenly balanced.

It is also important not to view a balloon payment as an alternative to an upfront deposit.

A healthy deposit on a new or used car will always reap dividends further down the financial road, as it will not only bring your breakeven point forward, but it will also lower the monthly repayment costs and the deferred debt held in the balloon.

We always advise our customers to look beyond the repayments when gauging what they can afford when buying a car. With vehicle ownership a monthly instalment is not the bottom line, as other responsibilities including fuel, insurance, tyres, regular upkeep and unrelated living expenses also need to be factored into affordability. There’s a big difference between being able to afford a car and being able to afford owning it.

Ghana Msibi is CEO of WesBank Motor Division.

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Balloon payments have one purpose only. That is to allow car dealerships to advertise a low monthly instalment price and obscure the real price of the car. Only recently have they been compelled to disclose all info like total cost of finance.

Do you know why they offer such attractive below prime interest rates? Because they can make up the short fall on deferred interest on the balloon payment.

The comment on break even point is also bunk. When you go to trade in you car the dealership will offer you 20-30% less than market value, because ‘they need to make money’ selling your 2nd hand car. 90% of the time you will owe money unless you luck out and happen to get a vehicle in high demand and limited supply on the used market.

Agreed. South Africans are obsessed with driving status symbol cars. I visited France last year and was amazed to see how many midde class families drive cheaper cars than South Africans. And don’t raise the public transport argument as I am talking also about small towns with no public transportation. Often families there only have one car as well. By contrast South Africa has got thousands of 4×4’s which has never driven on a dirt road. People buy well above what they can afford and balloon payments are just one way to do it.

Why not simply advise your customers to buy a car they can actually afford without the expensive balloon, repay it over the shortest term possible and keep it for at least 10 years or as long as it’s reliable, which with regular maintenance should be over 10years with modern cars. No one really needs the gimmicky features of newer models, besides most of these features can be fitted aftermarket anyway. Indebted South Africans pay a fortune for an exponentially depreciating piece of metal, rubber and plastic, at times much more than an equivalent income-producing asset which later can pay for the vanity purchase.

Well said serene.

Uhm…now wait for your dealer principal boss to approach your desk:

“Serene, you have been FIRED from our new car sales team with immediate effect! In our business we don’t tolerate such (truthful) opinion! Now, out you go!”

😉

People in high positions with no technical understanding of what they’re doing or saying will always put the layman in danger, simply cause they have a lot followership, louder voices and people trust their opinions.

In short, this article just suggested that it’s wise to take a balloon and save money on the side to settle the ballon later. How? Firstly, and this is not discussed a lot and should’ve been mentioned here, that the borrower pays interest on the ballon itself. What makes the monthly installments cheaper is that there are no capital (only interest) contributions towards the balloon portion for the period of the loan, the capital is paid at the end. With that being said, how on earth would it make sense to save money at a lower rate while paying a higher interest on the balloon for 5-7 years? The smart thing, if you have money to save on the side (as suggested here) is just remove the balloon and increase your installment. And the title says “How to use balloon payments to your advantage” please respect us….

Theres no advantage in paying off a car

You are paying interest every month and the interest you make on your savings is genuinely LESS than that of which you are paying. Add up all your interest House, car, credit cards, loans, etc… You are going BACKWARDS! Also, you are paying interest on a depreciating asset and you will NEVER have money to get out of that. ALWAYS PAYING INTEREST IS NOT A REAL GAME PLAN.

When your folks don’t buy you your first car it is the only way to go. Unfortunately after that people tend to get caught up as they buy more and more expensive cars.

The only worthwhile Balloon Payment is cash up front .
If you cant buy a car for cash , you cant afford it .
Cars bought on credit should be banned .
Its all about impressing someone or other.

Never take a balloon payment!
When you start working a new car’s payment is out of reach.
So buy a secong hand car and pay it off quick.
Then KEEP ON paying the payment amount in a savings account (after all you are acustomed to do without this amount) for another 2 to 3 years.
Then upgrade and now you’ll be able to put down 30% to 40% of the next car’s value, but pay a bigger payment than necessary. Again keep on paying the payment when the car is fully paid, again about 3 years.

Now you’ll be able to afford your car you want. BUT (there’s allways a “but”) agter paying off the car keep on saving the full payment each month.

Can you afford your sentiment? I need that fancy car because I can get to work 40 seconds earlier!
Do you have discipline? You better acquire it quickly if you don’t have it. Don’t want to be disciplined? Go suffer the rest of your life, the choice is your’s.

It worked for me.

Fake NEWS !!! “A balloon payment allows a buyer to take an amount owing on the purchase price of a car and set it aside” You forgot to add this.
WHILST YOU ARE PAYING INTEREST ON THE ENTIRE AMOUNT!!!!

There simply is no advantage to a balloon payment – all it does is enabling gullible people to buy cars they cant afford. It should be illegal.

Comments are spot on. Buy the car that you can pay for in cash. I am 45 now and never financed a car. Saved a fortune. Also never buy a new car. Cars are for transport, not to stroke your ego.

Your problem is to now repair that capital which you spent on the car which may take some time and also you have lost the interest earning capacity of using capital to buy the car. A different approach may be to negotiate with your bank that they buy the car and you service an installment credit line, but allow for balloon payments and a restructure of the installment credit annually with a commensurate interest adjustment, but maintaining the same monthly installment – i.e. no reduction over the remaining term

A balloon payment helps customers drive the cars they love and can afford to service through reduced monthly payments. Surely they must make plans about the expected settlement of the balloon payment at the end of the lease. Regarding interest on the deferred payment, yes its an expense but nothing different from the same cost paid when someone uses an overdraft or credit card to fund current expenses and expecting to settle with future income. Many private bank clients are in this boat and hence they are treated like royalty by bankers due to the heavy interest cost they pay to the bank on combined facilities annually. We are all wasting money on different things, some on paying expensive private school fees, some living in multimillion rand homes, some going on expensive holidays to return with pictures to be posted on social media, restaurant dining etc. My point is, if one wants to waste money on a BMW or a Merc or whatever, let them manage cash flows through balloon payments if they have other needs to deploy their monthly income on while not forgetting about that last payment. They keep the banks in business.

Agree. Your comment is good for new car sales. “Someone has to keep the dealers and economy going.”

Max it out! You CAN afford it! You only live once!

(But if that one life you have, is burdened by the PAIN of eternal debt, is it still worth it? Many people prefer financial freedom instead…)

I totally agree with you. I was doing work that needed me to travel 1000km every weekend. I needed a reliable and safe car, but the installment were on the upside. My toyota yaris at that time would not handke this for a year. So I bought a safe and reliable car and took a Balloon payment which is due this March. What I also did, I took out a US dollar offshore investment which is maturing around the same time. So in essence, I have saved enough money for my balloon payment and I will also have some money left from my investment. This is not to say I dont agree with everyone else who are against balloon payments. Balloon payments are not for everyone. You should be disciplined and have a plan on how you will pay for the balloon without having to refinance thereby paying interest on interest.

Balloon payments just allow dealers to advertise a monthly installment rather than the actual purchase price so people suddenly jump up and think they can afford it. They end up paying interest on that balloon amount for years before finally having to repay that balloon in any case.

An article written by a finance house, which lifeblood depends on the number (and size) of finance deals coming from new (and used) car dealers.

Obviously the balloon method will the promoted, to help car sales along, i.e. more finance business.

If one argue that the best deal would be to buy used (say between 2-4 yrs after huge initial depreciation is taken by new owner), and to pay it off over shortest term & what you can afford. That would be considered “ghastly advice” coming from a finance house 😉

When I financed my car I found I could deposit money into the account and it would earn interest. When you built up enough cash in it you can ask them to either reduce the length of the contract or the installment amount.

End of comments.

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