If you've been shopping around for car finance, you've probably come across the term "balloon payment." It sounds complicated, but it's actually a pretty simple concept — and understanding it could save you thousands.
What Is a Balloon Payment?
A balloon payment is a lump sum you pay at the end of your loan term instead of paying it off during the loan. Think of it as deferring part of your loan to the very end.
For example, on a $40,000 car loan over 5 years, you might choose a 30% balloon payment. That means:
- You make regular repayments on $28,000 over 5 years
- At the end of the loan, you pay a lump sum of $12,000 (the balloon)
Why Would You Choose a Balloon Payment?
The main reason people choose balloon payments is to reduce their regular repayments. Because you're financing less during the loan term, your weekly or monthly payments are lower.
This can be useful if:
- You need lower repayments to fit your budget
- You expect your income to increase before the balloon is due
- You're using the vehicle for business and want to maximise cash flow
- You plan to sell or trade in the vehicle before the balloon is due
The Downsides of Balloon Payments
Balloon payments aren't free money — there are real costs to consider:
1. You Pay More Interest Overall
Because you're not paying down the principal as quickly, you end up paying interest on a higher balance for longer. Over the life of the loan, this can add up to thousands of dollars extra.
2. You Still Owe the Balloon at the End
When the balloon comes due, you need to have the cash ready or refinance. If you can't pay it, you could be in trouble.
3. You Might Be "Underwater"
If the car depreciates faster than expected, you could owe more than the car is worth when the balloon is due. This is especially risky with new cars that depreciate quickly in the first few years.
Quick Example
Without balloon: $40,000 loan at 7% over 5 years = $792/month, total interest $7,500
With 30% balloon: Same loan = $554/month + $12,000 balloon, total interest $9,200
Lower repayments, but $1,700 more in interest.
When Does a Balloon Make Sense?
A balloon payment might be right for you if:
- You're certain you can pay it off — you have savings or expect a bonus/income
- You're trading in before the balloon is due — common for people who upgrade every 2-3 years
- It's a business vehicle — cash flow benefits and potential tax advantages
- You need lower repayments NOW — but have a concrete plan for the balloon
When to Avoid a Balloon
Think twice about a balloon if:
- You don't have a plan for paying it off
- You're buying a car that depreciates quickly
- You're stretching to afford the car in the first place
- You plan to keep the car long-term
What Happens When the Balloon Is Due?
When your loan ends and the balloon is due, you have three options:
- Pay it off — if you have the cash
- Refinance — take out a new loan for the balloon amount
- Sell or trade in — use the sale proceeds to pay the balloon (hopefully with some left over)
The Bottom Line
Balloon payments are a tool, not a trick. They can be genuinely useful in the right circumstances, but they're not for everyone. The key is understanding the trade-offs and having a solid plan for when the balloon comes due.
Not sure if a balloon is right for you? Get in touch and we'll help you run the numbers for your situation.