Balloon payments can seem like an extremely attractive financial option, especially for those really expensive and necessary purchases in life. Like a car or a house, which, in spite of their exorbitant costs, are nevertheless essential.

In South Africa, though, it’s more common to get finance for a car with a balloon payment than it is for a property, so we’ll direct all our information towards balloon payments that come with vehicle finance.

Here is the information that we can help you with:

• What a balloon payment is
• How a balloon payment works
• Who balloon payments are best for

What is a balloon payment?

In its simplest form, a balloon payment is a portion of the total cost of your loan that you would need to pay at the end of your loan period. So, in terms of vehicle finance, it would be the amount set aside from the price of the vehicle you want to buy, to be paid at the end of the loan agreement.

Because of the nature of when this larger payment is made, a balloon payment is often referred to as a ‘residual payment.’

The main reason why people consider a balloon payment is to make their repayments more affordable is because when you take out vehicle finance with a balloon, the installment amount is calculated on a lower value.

How does a balloon payment work?

In a way, a balloon payment works like a deposit, however, while a deposit is an amount of money that you pay upfront to reduce the total size of the loan, a balloon payment is due to be paid at the end.

When you take out vehicle finance without a balloon payment, you make your fixed payments every month until the end of the loan period – bringing the total amount that you owe on the vehicle down to zero.

On the other hand, when you take vehicle finance with a balloon payment, you’ll pay a reduced fixed amount until the end of the loan period – at which point you won’t have a zero balance. Instead, you’ll have to pay the outstanding balloon in a single payment in order to complete your financial agreement with the lender.

How a balloon payment is structured?

A balloon payment often equals a percentage of the purchase price of the car you want to buy. For instance, if you want to buy a car that costs R300 000 and you’re able to secure a 20% balloon payment to bring your repayments down, this balloon would work out at R60 000.

As a result, your loan repayments would be calculated based on R240 000, not the full R300 000, which would make them a lot less.

What you need to keep in mind, though, is that this R60 000 must be paid in one lump sum at the end of the contract period, usually 60 months or five years after purchase.

Who balloon payments are best for?

Essentially, a balloon payment is a financial tool that you can use to make your car repayments more affordable. With that in mind, you would think that it’s good for just about anyone.

We would say that while a balloon payment is helpful in its ability to make it easier for you to honour your monthly commitments, it would be a mistake to think that’s ideal for absolutely everyone.

For instance, if you don’t have a good credit score then a balloon payment might not be the best tool. Balloon payments are also not ideal if you don’t have room in your budget to make your vehicle finance payments in their reduced state, leaving nothing to be saved for the balloon.

Generally, though, these loans are good for borrowers who have excellent credit and a substantial income.

Feeling informed?

A balloon payment plan sounds like a weightless option to help you buy a vehicle, but this seemingly weightless financial support can quickly turn into a lead balloon. That is, if you don’t manage it properly.

We hope that this information will prove useful.

Don’t forget that AA Inform is home to a range of tools and information, including trip fuel calculators, property valuation reports, and advice on whether you should get a warranty, maintenance or service plan for your car.