How to Use a Balloon Payment on a Car Loan Wisely

A balloon payment lowers your monthly car loan repayments by pushing part of the loan to the end of the term.

If you are saving for a first home on one income, that lower repayment can look very appealing. It can also leave you with a large bill just when you want your finances tidy for a home loan. This article walks through how it works, what it costs and when it might suit you.

What Is a Balloon Payment on a Car Loan?

A balloon payment is a lump sum you agree to pay at the end of a car loan, so your regular repayments only cover part of the loan amount. Lenders set the balloon, often as a percentage of the vehicle price or amount financed. Maximum balloons and eligible vehicles vary by lender and term.

You still pay interest on the full balance during the term, including the portion left for the end. That is why the monthly figure drops, but the total cost usually rises.

Balloons tend to sit on a secured car loan, where the vehicle is the security for the debt. If you cannot pay the lump sum when it falls due, the lender can have rights over the car, so it pays to plan for it from day one.

How Much Can a Balloon Payment Lower Your Monthly Repayment?

A balloon can cut a monthly repayment noticeably, but the exact saving depends on your interest rate, term and balloon size. Here is an illustrative example using a rate of 6.75% p.a.

Consider a first home buyer on a single income who needs a reliable family car. They borrow $35,000 over five years. With no balloon, the monthly repayment comes to about $689. With a balloon of 30% ($10,500) at the end of year five, the monthly repayment drops to about $541, which is roughly $148 less each month.

That extra room in the budget helps with saving for a deposit. But at the end of five years, they still owe $10,500. Because interest is charged on that amount the whole time, they also pay more interest overall than with the no-balloon loan.

To test your own numbers, the loan repayment calculator is a handy place to start.

What Happens When the Balloon Falls Due?

When the balloon is due, you can pay it in cash, refinance it, or sell or trade in the car to cover it. Each option has a catch, so choose your plan before you sign.

In the example above, the buyer has three paths at year five:

• Pay the $10,500 from savings. This works only if they kept saving for it, which competes with the home deposit.
• Refinance the balloon into a new loan. They keep a car, but they start another loan and are still paying off a car they have owned for five years. A car loan refinance can be an option, and approval depends on their circumstances at the time.
• Sell the car. If it sells for less than $10,500, they must cover the gap.

In the example, the buyer picks the sell option. The car sells for more than the balloon, they clear the debt, and the remainder goes into their deposit savings. That outcome is not certain. Cars lose value at different rates, and a lower sale price would have left a shortfall to pay.

Call one of our team or book an appointment to talk through whether a balloon suits your plans.

Do Balloon Payments Affect Your Home Loan Borrowing Power?

Lenders assess your existing debts when you apply for a home loan, and how a car loan balloon is treated depends on the lender's policy. Confirm with your lender or broker before you apply.

On a single income, every commitment matters. A lower monthly repayment may help your budget, but the loan still shows on your credit file and in your assessment. Borrowing capacity depends on how your lender assesses the loan's repayments and balance. Ask your broker how a balloon car loan would be treated, and consider paying down or avoiding the debt before applying.

You can see the effect on your own situation with the borrowing capacity calculator. Our page for first home buyers also explains how we approach the home loan side.

When a Balloon Payment Suits You, and When It Does Not

A balloon payment suits someone who has a clear plan for the lump sum and a stable income. It is a poor fit if you are hoping the problem will sort itself out later.

It can make sense if:

• You expect to sell or replace the car at the end of the term.
• You have a reliable source of funds coming, such as a planned bonus or maturing savings.
• You want to keep monthly cash flow open while you save for a home.

It is riskier if you are stretching to afford the car at all, if your income could change, or if you plan to apply for a home loan soon after. Remember that the balloon is a debt you still have to deal with, and a larger balloon means a bigger risk of owing more than the car is worth.

Comparing Car Loan Options Before You Sign

A fair car loan comparison looks at the interest rate, fees, the balloon amount and the total cost over the term, not just the monthly repayment. A low repayment can hide a higher total cost.

Ask each lender for the comparison rate, any establishment or monthly fees, and what happens if you want to pay the loan out early. Ask how the balloon is set and whether you can change it. Dealer finance can be quick to arrange, but it pays to compare it with other lenders before you commit.

That is where a broker can help. We can compare options from a range of lenders and explain the trade-offs in plain language. You can read more on our car loans page.

Before you sign, ask yourself one question: if the car was worth less than the balloon in five years, could I cover the difference? If the answer is yes, the structure may suit you. If the answer is no, a smaller balloon or none at all may be safer.

Call one of our team or book an appointment at a time that works for you, and we will work through the numbers with you.

Frequently Asked Questions