Let’s say you’re in the market for a new car. After picking out the car, you’re given three payment options by the dealership: leasing, purchasing the car with a traditional auto loan, or purchasing with balloon auto financing. You’ve decided leasing isn’t for you, so you’re left with a traditional auto loan and balloon financing. If you don’t have a down payment saved up, the lower monthly payments of the balloon loan and no down payment requirement look enticing, but you need to understand just how you’re getting this low monthly payment and how you’ll pay for it in the end.
Balloon loans are structured so you make lower monthly payments by moving what would be a sizeable down payment to the end of the loan. For example, you might be able to save $100 a month on your car loan with a final installment (also called the “balloon payment”) of $6,000 due at the end of the loan’s term. Because lenders (whether the dealership or a credit union) front-load interest on the payments, the final installment pays for the remainder of the loan’s principle. You can pay off the final balloon payment at once with cash (possibly from selling the car) or by re-financing with another loan and paying more in interest.
This type of auto financing can be a good option for those with good credit and a stable income who need a little more time to save up and pay off the loan, all while making lower monthly payments. Before you sign up, however, here are some things to consider first.
- It’s sometimes difficult to refinance the remaining balloon payment if you can’t pay it off completely when it comes due. If you do refinance, your original loan period will extend, incurring more interest.
- Will you truly be in a better financial situation when the final payment is due? If you can’t afford a down payment now, what are the odds you’ll have those thousands of dollars on-hand in three to five years?
- If you can’t refinance the balloon payment at the end of the loan, how will you pay it off? Not making the balloon payment will hurt your credit score and you will lose the care.
- If you plan to sell the car to make all or part of the balloon payment, it’s possible that, due to depreciation, you’ll owe more on the car than it’s worth.
Like all financing decisions and options, balloon auto financing should be considered after thorough research and consideration.