What is a Balloon Loan?
What is a Balloon Loan?
Posted on March 26, 2021
Today we’re tackling an unusual customer query our Smithville auto loan team were asked the other day; the "balloon loan". The question was around balloon auto loans and balloon payments and whether they were a good idea or not.
As we hadn’t been asked that question for a while, we thought it was a prime candidate for a blog post.
What is a balloon loan?
A balloon auto loan is not a standard form of car finance but is sometimes offered by smaller dealership or lenders.
The loan will usually include lower monthly payments over the term with a final lump sum payment at the end. It’s similar to an interest-only loan where your monthly outgoings are lowered in return for a large payment at the end.
They aren’t typical auto loans and most mainstream lenders don’t offer them.
A simple interest loan divides the amount you borrow with the amount of interest charged over the number of months of the loan. This is your payment over the entire term of the loan.
A balloon auto loan includes a portion of the amount you borrow and sometimes interest is set aside until the end. You pay a portion of the principal, the amount you borrow alongside the interest on that amount.
Then, at the end of the loan, you pay a lump sum to settle the loan in full. That lump sum is the balloon payment.
The amount of that balloon payment is often linked to the potential resale value of the car but doesn’t have to be.
Your options at the end of a balloon loan
When the balloon loan comes to an end, you can either make the payment and keep the car, refinance the payment with another loan or return the car to the lender to pay off that balloon payment.
If you choose to return the car, some lenders will add fees just like returning a lease. They include excess mileage fees, wear and tear excess charges and perhaps a disposition fee.
A disposition fee is a formal term for what it will cost the lender to take back the vehicle and prepare it for sale.
All these fees will be outlined in your loan paperwork and should be made clear before you sign the loan.
Are balloon auto loans a good idea?
In our opinion, balloon auto loans are not generally a good idea. They often charge higher interest rates than a standard loan, those end fees can be substantial and you’re just saving a financial headache for the end of the loan rather than paying for it as you go.
You would be far better off borrowing less or buying a cheaper car. You’ll have nothing you need to save for, no worries at the end of the loan and no potential fees to have to pay. Plus, once the loan is paid, you’re free and clear and you don’t have to wonder how you’re going to pay the balloon payment.
Contact Unique Chrysler for help, advice and competitive Smithville car finance and leasing.