Not sure how car loan balloon payments work? Our guide shows you how.
When researching your car loan options, you’ve likely found lenders that offer balloon payments to lower the monthly cost of your vehicle. However, this comes at a cost. The final payment you make on your loan will be much larger than the others. Is it worth the trade off? Our guide will help you decide if you should opt for a balloon payment or stick with a more traditional payment schedule.
What is a car loan balloon payment?
A car loan balloon payment is a large payment that’s due at the end of your loan following smaller monthly payments. Car loan balloon payments are a way of scheduling your monthly payments so that the interest rate stays small and the loan term is short.
Like other loans, you’ll be making regular payments over the course of your loan, but at the end of the term, you’re required to pay the remaining principal. That means you’ll be on the hook for hundreds or even thousands of dollars after up to five years of making payments.
This is because you’re not really paying off much of the principal with your monthly payments. Instead, you’re working down the interest, leaving the principal largely untouched. You’ll end up keeping your monthly payments small, but it comes at the cost of owing a hefty amount at the end.
What are the benefits of a balloon payment?
Although you may owe a large amount once your loan is up, balloon payments have their benefits that include:
- Reduce your monthly payments. This is the main advantage of a balloon payment schedule. You’re only paying off your interest so your monthly payments will stay small and more affordable.
- Build up your savings. You’ll know from the start how much your balloon payment will be. This means you can start saving for it as soon as your loan begins, earning interest on money that would otherwise be going into your lender’s pockets.
- Determine the payment amount. The balloon payment is generally flexible and can be set when you’re negotiating your loan contract. A standard balloon payment is a few thousand dollars, but can be more or less depending on the loan.
Two important questions to consider
Before opting for lower repayments with a balloon payment at the end of your term, ask yourself:
- How much additional interest will I be paying? While your repayments are lower, working out how much the lowered repayments are costing you in additional interest over the loan term is a crucial step. Are the long-term costs worth the short-term savings?
- How will I pay off the balloon payment? Many people put money away in a savings account or end up putting the amount on a no-interest credit card. Whatever you decide, have a goal in mind for how you will manage the final payment.
Are there drawbacks to a balloon payment?
While there are some benefits to having a balloon payment at the end of your car loan, consider some negative features before committing to a loan.
- Can lead to more debt. If you find yourself unable to save up for the final balloon payment, you could be stuck refinancing your loan and taking on even more debt.
- Risk repossession. When you take out a loan with a balloon payment, you run the risk of repossession if you can’t afford that final payment and don’t have the credit to refinance.
- Not actually cheaper. A balloon payment may make your monthly payments cheaper, but you’ll still end up paying the same amount as you would with a traditional payment schedule.
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Should I refinance a balloon payment?
Many dealerships make their money by refinancing balloon payments. If you’re coming to the end of your loan term and are unable to pay your balloon payment outright, auto refinancing could be a good option.
Take your time reviewing your options and making a final decision. You don’t need to refinance with the same lender, and the terms of a refinanced loan should benefit your financial needs.
Car loans with balloon payments can help keep your monthly payments low, but they do leave you with a large payment to deal with at the end of your loan. Keep your financing options open and consider other car loans before you decide.