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How do balloon payments work?

When you buy a car and choose to finance it, you have a few options to consider. These include over how many months you want to pay off the car, and whether you want it to be fully paid off at the end of this period, or if you’ll have a balloon/residual payment, which is a lump sum that is due at the end of your repayment period.
Barend Smit, Marketing Director of MotorHappy, a supplier of motor management solutions and car insurance options, uses the following example to explain how balloon/residual payments work: James is buying a new car for R350,000. He doesn’t have a deposit, so he’ll be financing the full amount. If the interest rate is 10% and the car is financed over 60 months with no balloon payment, James will need to pay around R7,531 a month.
“If James chooses to include a balloon payment in his financing, for example 30% (R105,000), then his monthly repayment would be lower, around R6,175. However, at the end of the five-year term, he would still need to settle his balloon payment,” says Smit.
If you opt for a balloon payment you can choose one of the following ways of settling it:

  1. Trading in your car for a newer model and using the amount you receive for your old car to settle the payment.
  2. Refinancing the payment with the bank so you can continue to pay it off.
  3. Using other savings you have to settle the payment.

“The advantage of including a balloon payment is that you lower your monthly costs, however you’ll end up paying more in interest over the life of the loan as the loan amount will not be decreasing as quickly,” cautions Smit.
Decide on your budget before you get to the dealership, and don’t be seduced into those extras. “Remember, a car costs more than those monthly instalments – you need to factor in insurance, maintenance and fuel costs,” says Smit.
Don’t fall into the trap of purchasing some extras that you probably don’t need. If you have a tight budget, Smit says you should avoid extras like SatNav, sunroofs, in-car entertainment and fog lights.
Pay attention to the financing terms. It makes no sense to negotiate the price down, but then pay more long-term. If you’re buying a car through financing, shop around for a good loan. You can either take out a finance agreement that will result in your car being paid off at the end of the term (e.g. 60 or 72 months), or you can lower your monthly instalment by opting to have a balloon payment at the end of this period.
Before you commit to a new set of wheels, Smit points out just how important it is to do proper research. First, go online to check out any reviews on the make and model – not only in South Africa but all over the world. Ask your friends and family what they think of the car, but don’t forget to chat to a qualified professional too. Certified mechanics who are not affiliated to the dealership might be able to share some valuable information.
“Of course, a thorough test drive is also part of your research, and can usually be quite a fun experience!” says Smit. “Test drive more than one car, drive on the highway, drive on quiet suburban roads – even take passengers along for the drive.”
Also be aware of the car’s depreciation rate.
“Did you know that your car depreciates in value as soon as you drive it off the lot? Use an online calculator to check your car’s depreciation rate. This could be helpful when deciding between two similarly priced cars,” advises Smit. “If you’re cost-conscious, consider buying a good used car or demo model – that way someone else has absorbed the depreciation costs and you get to simply enjoy your car.”