With the global economic recession1 today, more and more people are finding themselves trapped in a financial rut. People are struggling to pay their car insurance premiums2, mortgages, school loans, among other things. Others are looking for ways to save on car loan repayments and not finding the most suitable solutions. Well, if you’re looking for ways to save on the monthly repayments, you might need to consider balloon payments or a residual value loan.
Nevertheless, with these options, it can be challenging to settle the unsettled balance on your dream car at the end of the car repayment term. Therefore, it’s vital to look at all the factors before you decide on taking that route.
With that, here’s a comprehensive guide on balloon mortgages and how they might be what you need to help you manage your car repayments.
What’s A Balloon Payment?
It’s a lump sum amount that you as the car owner pays at the end of a loan term. It’s the final payment due and you, as the borrower, and the plan provider will sign a contract of the agreement beforehand to decide the percentage of the ultimate loan amount that should make up the balloon payment3.
Today, most people are opting for this plan since it drastically reduces the monthly repayments, thus allowing you to manage your finance’s. In theory, this financial product will enable you to have some extra cash that you can save for the lump sum payment at the end of the loan term since you pay less every month. Nonetheless, budgeting and saving this type of cash can be challenging. If you can’t pay the balloon payment when it’s due, your loan provider will sell your car or even refinance it.
How Does the Balloon Payment Plan Work?
Well, for instance, if you purchased a Sedan worth $60,000 with a car loan term of five years, and an interest rate of 5%. You and your plan provider agree on a balloon payment of 25% or $10,000. As a result, you’ll only have a monthly fee of $926. It’s way cheaper than having to pay interest on the full amount of $60,000, which is $1,114. Using the balloon payment, you’ll have the chance to cut your regular repayment by $216. It’s, however, not likely to save cash in the longer term, since you still have to make the balloon loan at the end with more accrued interests.
Balloon payments do make your life more comfortable at first. However, you need to ensure that you the lump sum amount ready or consider other options when your finance term ends. So, that begs the question, what do you do if you’re not sure that you can save the lump sum amount in time? Also, are you sure you know how much you can afford for a car?
Well, there’s always another financial option which requires less of a commitment from you than the balloon payments– the incredible residual value loan.
What’s A Residual Value Loan?
It’s a financial product that applies the same principles as a balloon payment but works a bit differently. The plan is for you to lease a vehicle for a certain period and pay the lump sum at the end of the lease term if you want to own the car.
You’ll still pay a monthly amount during the lease term, just like you would with the balloon payment. Nevertheless, you’re not committing to purchasing the vehicle in the long-run. If you choose to, however, you can return the car to the vehicle plan provider or sign a new lease agreement for it and continue to lease the vehicle for another set period.
You can get lower premiums for new vehicles. However, when it comes to second-hand cars, you could be subjected to higher monthly premiums since their value depreciates with time. The lender may monitor the miles you travel in the new vehicle and could penalize you for the high mileage or a lack of proper maintenance. It’s because a vehicle’s mileage and condition can have an impact on its resale value.
Is A Balloon Payment A Good Idea?
For those who are financially disciplined to save the amount required, a balloon payment might be your best option. It’s also an excellent option for investors since it helps in freeing up short-term capital. In most cases, though, balloon repayments are the easiest way to find yourself entangled in more debt. Average income earners who can’t afford the initial repayment can also not amass the amount required to settle the lump sum at the end of their repayment period.
Most people don’t think of the long-term ramifications about balloon payments. If you don’t have a solid budget plan, you can end up paying more than you bargained for. Most people know how it’s easy to go over their budget when you’re set on a specific vehicle, especially when the balloon payment option looks so tempting.
Unfortunately, most people in this position, people can’t often pay the loan amount at the end of the finance term, thus ending up in debt. As security against this, most financing firms often require evidence that you’ll be able to afford future balloon finance. Unless you’re confident that you can manage to pay for this financial option, you’re better off buying an affordable vehicle, one that’s within your budget.
To ensure you save cash on your whole financial deal, make sure that you select the shortest repayment period possible and consider paying a deposit on the car, both of which could save a couple of bucks.
What Are the Pros and Cons of Balloon Payments?
If you’re a first-time buyer, a balloon auto loan or residual car loan can be puzzling. Before you get excited and sign up for a product you don’t understand, make sure you read all the terms of the contract and what the loan provider expects of you.
If you’re not particular about whether a balloon payment is your best option, here are some advantages and drawbacks to help you make a more concrete decision.
Pros of A Balloon Payment
- Unlike other financial products, with the balloon payment option, you don’t have to make any deposits
- It can be the ideal option to help with your capital flow management
- It allows you to free up short term capital and assist you in covering finance gaps
- The loan provider will charge you a lower monthly repayment fee
- A more significant loan size means that you can afford a new or more luxurious vehicle
Cons of A Balloon Payment
- The lender might not approve refinancing of your balloon payment id you can’t settle it at the end of the finance term4
- Not affording a balloon payment can lead to a cycle of debt since you’ll be forced to refinance it
- If you don’t pay the balloon payment, and you default it, your lender might force you to sell the vehicle, some time for a less amount than what’s still outstanding on it. If this occurs, you might end up without your dream car and still entrapped in debt
- A loan that includes a balloon payment is much riskier and complex than a typical mortgage with a standard repayment schedule
It’s a lump sum that you pay at the end of the loan’s term that’s significantly greater than all of the payments you make before it. On instalment mortgages without a balloon option, your lender requires you to make a series of fixed payments to pay down the mortgage’s balance. These payment options allow you to reduce that fixed payment amount in exchange for making a large payment at the end of the loan’s policy. These loans are excellent for those who have incredible credit and a substantial income.
The balloon payment option reduces your monthly loan repayments. It enables you to finance your vehicle with monthly payments that are usually lower than the fees you’d have made with a traditional car loan. However, this plan comes with its drawbacks, and you can end up entangled in more debt.
There are several favourable ways to settle or reduce your balloon payments, and some of these include:
- Settling the outstanding balance in full. Paying off your final debt is an excellent idea if you’re sure that you’re going to have some cash at a later stage. It helps you save some money on interest, and you boost your credit score, too.
- Refinancing the balloon payment – if you can’t pay the full amount by the end of the finance term, then refinancing is your best option.
- Trading in your vehicle – if you can’t pay the outstanding balance or can’t refinance, then you can sell your car. You use the capital you get from the sale to settle the balance.
Well, you need the balloon payment calculator to figure the amount you’ll pay the end of the loan term.
Purchasing a vehicle is one of the most significant financial ventures you’ll embark on in your lifetime. A balloon payment can be an ideal option at the moment, and yes, it could help you save capital on your monthly car repayments. Still, the long-term financial impact could be unfavourable to your future without proper preparation. You have to make sure that you think about it carefully, consult a financial advisor and if you think you it’s your best option, then you can go ahead and take it.
Also, make sure you brush up on car insurance write-offs before you make a decision.