A balloon payment is a lump sum payment that is due to the bank/loan provider at the end of the loan term.
According to the National Credit Act, a balloon payment can be offered to any consumer on an instalment sale agreement.
What most people forget is that even though the balloon payment is set aside, it remains part of your finance agreement and is payable by you.
Does the balloon payment set aside accrue any interest?
Usually, the interest is calculated on the full loan amount inclusive of the balloon payment.
How does the balloon payment reduce my monthly instalments?
Monthly instalments are calculated based on the total loan amount less the balloon payment which tends to reduces the monthly instalments. Loan amount is N$300 000 and your balloon payment is N$90 000, your instalment is based onN$210 000.
What happens when the balloon payment is due?
Most banks will notify before the balloon amount is due to give you time to consider your options. You generally have 3 options:
1) Pay the full balloon amount
2) Refinance the balloon amount
3) Sell or trade in the vehicle
Pay the full balloon amount
If your balloon payment was say N$90 000 (30% of N$300 000), you will need to pay this up front.
You need to plan around this. Where will you get the N$90 000? Will you save for this monthly before it’s due? Will you use your bonuses?
Refinance the balloon amount
With this, you enter into a new loan agreement. Back to the N$90 000, you will need to finance this like it’s a new car at a different interest rate depending on your creditworthiness over maybe 12, 24, 36 or 48 et al months.
Sell or trade in the car
You can sell the car and use the proceeds to settle the outstanding amount, including the balloon payment. Well, this is if you get a good deal. Most car depreciate at the speed of light and you might sell for less than what you still owe plus the balloon.
The total cost of credit after all is said and done is usually higher for a financing option that has a balloon payment vs that without a ballon payment. Your joy is only experienced with a reduced instalment.
Make sure you read the instalment sale agreement with a fine-tooth comb so that you know whose who in the zoo.
Wesbank has previously reported that on average 1 in every 5 funding agreements now includes a balloon payment that comprises on average 17% of the finance amount.
*By BankerX, a technology company solving urgent economic problems through a connective platform disrupting traditional methods of career development, financial education, and access to capital.
