What Is a Balloon Auto Loan?
When shopping for a car, getting your financing in order is important before you step into a dealer showroom. Doing so will allow you to shop as a cash buyer and even control your financing rate since you can shop for the best rate beforehand. We recommend going with a traditional loan, in which you pay equal monthly payments for a set amount of time to pay off the cost of the car. However, a balloon auto loan is possible as well. But what is a balloon auto loan?
A balloon auto loan has small monthly payments that inflate at the end
Manufacturers typically offer auto balloon loans, but auto loan lenders and credit unions offer them as well. With an auto balloon loan, the lender lays out a series of small monthly payments that lead up to a lump-sum payment at the end of the repayment schedule — also known as the “balloon payment.” According to Lending Tree, “The amount is usually thousands or even tens of thousands of dollars, often around half of the car’s value.”
In that case, a balloon auto payment could work for those wanting small monthly payments but have the plan to pay the large payment in the end. Remember that the lower monthly payments don’t mean you’re paying less for the car; they’re a different way to structure the loan.
Additionally, the lump sum payment is a set amount determined by a percentage of the vehicle’s value at the end of the loan. For example, if the car is worth $24,000 at the time of purchase and will be worth $15,000 at the end of three years, the balloon factor will be 62.5%.
There are pros and cons of a balloon auto loan
As with any auto financing or leasing structure, there are pros and cons to going with a balloon auto loan. Here are the pros:
- Smaller monthly payments: Wouldn’t you rather make $300 monthly payments instead of $500 ones? Of course. By opting for a balloon loan, you can save money during the loan schedule to pay the lump sum at the end.
- It can buy you time: If you don’t have all of the money you need right now for a traditional auto loan, you can buy the car with a balloon loan and pay smaller payments for a while. This will buy you time and allow you to save your money for the big payment later or invest in a high-interest account.
On the other end of the coin, there are a few cons to going with a balloon auto loan:
- The large lump sum payment: Although you can save up for the large payment at the end of the loan, you need really good budgeting skills to do so. If not, you may have trouble paying that lump sum payment, which could present more problems later on.
- Upside down on the loan: One of the dangers of having a balloon payment is possibly being upside down on the loan. That means that you could owe more than the car is worth since you’re only making small payments. In this case, you could owe more money than the car is worth when the last payment comes around.
- Higher interest rate: Lenders consider balloon payments to be riskier than traditional auto loans, so they typically come with higher interest rates and fees. Although your monthly payment is lower, you could pay more in the long run.
Are car balloon payments a good idea?
If you can pay the larger payment at the end of the term, then the balloon loan could work for you. However, there are risks involved in terms of being upside down on the loan or not being able to pay the larger sum back.
There are a few options if you can’t pay the large payment in the end. You can sell the car to pay off the amount owed, roll over the residual amount to a new loan on a different car, or refinance the balloon payment with another loan. None of these solutions are ideal, but they can get you out of the loan if needed. Either way, it’s important to have your budget figured out if you plan to go with a balloon auto loan.
