You know that person who drives that fancy car you know they can’t really afford? Don’t be that person! Balloon payments are for those people. I get asked about balloon payments far too often and my advice is to avoid them at all costs.
WHAT IS A BALLOON PAYMENT?
A balloon payment (also known as a residual) is a lump sum of money owed at the end of a loan period. The reason for it is that it brings down your monthly instalments on a car, which can be very appealing. But be warned, you are being a dumbass.
WHY SHOULD YOU AVOID BALLOON PAYMENTS?
Because you can’t actually afford the car, that’s why. Sure, you are already financing it and so technically you cannot afford it, but you know what you can afford monthly. The higher the total cost of the car, the higher your monthly payments will be, obviously. So if you cannot afford that monthly cost, why do you think that by ‘reserving’ that massive amount for later, will help?
You might be able to afford that lump sum in five years time when it is due, but what if you can’t? Why risk it? No one is able to predict where they will be financially in five years time. (Unless you’re Nostradamus, obviously)
HERE’S AN EXAMPLE
Wesbank gives a great example of why you should NOT go with a balloon payment:
A balloon payment of 20% on a vehicle of R240 000 will result in monthly repayments of R4 739.58 (over 60 months, at 11.5% interest).
At the end of the finance term the repayments will total R284 374.84. However the buyer will still owe a 20% balloon payment – or R48 000 – thus bringing the total price of the vehicle to R332 374.84.
Crazy, right?! That’s almost R100 000 more than what the car actually cost.
IS THERE EVER A GOOD TIME TO GET A BALLOON PAYMENT?
I will say no. However, not to be a total naysayer and for the sakes of good journalism, I shall look at both sides of the argument (although, I think it is pretty clear which side of the argument I am on). If you know exactly what you are doing and you buy cars often, in other words, if you trade in your car every couple of years before the balloon payment becomes owing, you then enter in to a new term on your next car. You are the type of person who might be able to get away with a balloon payment. But first-time car buyers should definitely avoid it.
According to Wesbank, ideally, the vehicle should be traded in when the outstanding loan amount owed to the bank is equal to the vehicle’s trade-in value, which is affected by the age and mileage on the car. This is called the “breakeven point”. Trading in the vehicle at the breakeven point means that the buyer won’t have to pay in any funds to settle the loan.
This does not happen all too often, as you can imagine.
I think the bottom line is pretty obvious. Don’t live beyond your means. A car is in no way an investment, you do not get all of that money back. If you spend more than you can actually afford, well then, you’re being a tool. And don’t get me started on the maintenance costs you still have to factor in…