Not many of us can afford to buy a car with cash… whether you’re in the market for a new model or intend to purchase a pre-owned car, a key step in the car-buying process is figuring out how you’re going to pay for it…

Many prospective buyers find that vehicle financing is the only way they’ll be able to afford a car.

There are many options involved with the purchasing of a vehicle, and once you decide what car you want, the next decision is to determine the correct financing for your needs.  If you are considering making use of a balloon payment or residual, here are some things you should know before signing the loan agreement.

What is a residual/balloon payment?

There are two different types of balloon payments – known as ownership and non-ownership residuals.

There are two different types of balloon payments – known as ownership and non-ownership residuals.

A balloon payment on a car loan enables the borrower to settle an inflated lump sum at the end of the repayment period, with interest having been accrued up until then.

In an ownership situation, you are buying the car and are responsible for the lump sum at the end of the loan term. Rather than extending the repayment on the total cost of the vehicle over the average six-year period, the borrower and the loan provider agree that a certain percentage be pushed to the end of the finance term.

This will keep the monthly instalment amount lower but when it’s time to settle the balloon payment, it needs to be paid as a single payment. If the buyer is unable to clear their debt on the balloon payment, they may need to refinance the amount due or sell the car.

With non-ownership option, the bank or lender still owns the car at the end of the loan period and is also responsible for reselling it to cover the balloon payment. In effect, you are leasing the car from the bank.  Make sure you understand which it is that you are agreeing too. With non-ownership the lender is responsible for the balloon payment, so you don’t have to worry about finding the money. There might, however, be certain restrictions you must comply with, like a mileage ceiling on the vehicle to ensure the resale value.

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The pros and cons of residual/balloon payments

Residual/balloon payments can be confusing, and below are some of the advantages and disadvantages to help you decide whether they will work for you.

Pros

  • A down payment is usually not required
  • A balloon payment can help with your cash flow management
  • You will be charged a lower monthly repayment fee during the first few years
  • An increased loan size means that you will be able to afford a new or more expensive car

Cons

  • When the repayment term expires, your vehicle will be worth less than what you paid for it
  • Could lead to a continued cycle of debt as you may have to refinance the balloon payment
  • If defaulting on your balloon payment, you may be forced to sell the car, but you might not get enough to cover the outstanding amount on the loan

Is a residual/balloon payment right for you?

It is often tempting to be led by your heart, rather than your head when shopping for cars, but one should carefully consider the repercussions of structuring a deal simply to have lower monthly payments, because you will ultimately end up paying a lot more.

It is often tempting to be led by your heart, rather than your head when shopping for cars

Here’s an example:

A balloon payment of 20% on a vehicle of R240 000 will result in monthly repayments of R4739.58 (over 60 months, at 11.5% interest). At the end of the finance term the repayments total R284 374.84, however the buyer will still owe a 20% balloon payment – or R48 000 –bringing the total price of the vehicle to R332 374.84.

If the owner trades in their vehicle, the outstanding balloon amount will be subtracted from the trade-in price. If the owner chooses to keep the vehicle, they can pay the amount as a lump sum or finance the outstanding amount, which will mean incurring further costs.

For a finance deal with no balloon payment the same vehicle would incur monthly repayment of costs of R5 335.23 (over 60 months at 11.5% interest), resulting in a total repayment of R320 113.55 – or R12 261.29 less than the deal with a balloon payment.

Visit your nearest Imperial Auto Dealer to assist you with further information on financing your car and join the conversation on Facebook.