One of the more common questions we receive from readers about car finance refers to balloon or residual payments. In many cases, it seems as though consumers who are eager to buy a car sign on for a financing agreement that they do not fully understand.
A balloon or residual payment refers to a portion of the selling price – the balloon amount – that is payable at the end of the agreement with the car dealer. Many car financers offer this option as it allows you to pay a lower monthly instalment. However, the full balance of that balloon payment must be paid whether it is at the end of the agreement or when you decide to settle your vehicle finance loan. Taking a balloon payment also increases the total cost of the car finance.
For example, you find a car that you really like for R500 000. However, the monthly instalment over five years is R11 400. You cannot afford this, so the dealer suggests that you take a 30% balloon payment option.
This means that R150 000 is put aside to be paid at the end of the agreement and your monthly instalment is calculated on the remaining R350 000.
This drops your monthly repayment to R9 700, so the car becomes “affordable”. What people do not realise is that, at the end of the five-year period, they still owe the bank R150 000 and the total cost of the loan is now higher. Over five years, you pay R48 000 more as the bank has been charging interest on the R150 000. If you do not opt for a balloon payment, you’ll pay R684 000 for the car over five years.
With a balloon payment, you pay R582 000 in monthly instalments plus the R150 000 at the end of the period – a total of R732 000.
According to the Motor Finance Corporation, even though the balloon payment is used to reduce your monthly instalments, it remains part of your finance agreement. This means that, when you ask for a settlement amount on your vehicle, the balloon amount is included in the calculation of the settlement amount. Should you decide to settle before the financed term is over, you will still have to pay the balloon amount as it formed part of your original agreement.
Some people think that any extra money they deposit to pay off the car sooner has gone towards settling the total debt. They are then surprised when they discover they still owe the full balloon payment amount. It is important to note that, unless you inform the bank, the additional car repayments will not be allocated to your balloon payment and will only be used to reduce the debt with the monthly instalment.
The best way to lower your balloon payment is to inform the bank that the additional funds you are paying must be used to reduce the balloon amount. Alternatively, you could open a savings or investment account to start saving towards the settlement of the balloon payment at the end of the contract.
MOST BANKS WILL NOTIFY YOU 90 DAYS BEFORE THE BALLOON AMOUNT IS PAYABLE TO GIVE YOU TIME TO CONSIDER YOUR OPTIONS. YOU GENERALLY HAVE THREE CHOICES:
Pay the full balloon amount: This assumes that you have R150 000 available to settle the balloon payment.
Refinance the balloon amount: This is a new agreement and means you must pay for an extra 12, 24, 36 or 48 months depending on the option you choose. The interest rate of this new agreement may also differ from your original agreement.
Sell or trade the vehicle in at a vehicle dealership and settle the outstanding amount:
If you decide to sell your car through a dealership, the dealer will first settle the outstanding amount which includes the balloon payment before paying the balance to you. If the amount is too little to cover the outstanding amount, you will have to settle it or refinance the amount. Even if you sell your vehicle privately you must settle the balloon payment. This option could however leave you stranded without a vehicle.
You could trade your vehicle in at a dealership and replace it with another vehicle. The trade-in value will then be used to cover the outstanding amount which includes the balloon payment. The dealership will pay the outstanding amount directly to the bank as part of the process. If the trade-in value does not cover your outstanding amount, you must either settle the outstanding amount or refinance it.