8 Advantages and Disadvantages of a Balloon Payment

What is a balloon payment?

One of the many benefits of car finance is the range of different agreements available. The right one for you will depend on your needs and circumstances. Some types of car finance have an optional lump sum that you can pay at the end of your agreement.

This one-off lump sum is known as a balloon payment. By making this payment, you’ll own the car outright.

Not all car finance agreements have the option of a balloon payment, but some do.

Personal contract purchase, or PCP, is one type of car finance agreement with a balloon payment. That said, this balloon payment isn’t obligatory – it’s optional. If you don’t want to own the car at the end of your finance agreement, you can always hand it back or choose another finance agreement on a different car.

Any balloon payment is calculated on the expected depreciation of your car. This depreciation refers to the difference in value between when you first purchased the car and when you come to the end of your car finance agreement.

In the context of a balloon payment, this depreciation value is referred to as the Guaranteed Minimum Future Value or Residual Value.

The GMFV or RV predicts what the car will be worth at the end of an agreement, based on your usage estimates. The factors that will impact its value include the make and model of the car, your yearly mileage estimates, and the length of your finance agreement.

The GMFV or RV is a fixed cost – it won’t fluctuate based on your car’s value.

Advantages of a balloon payment

It’s possible to find car finance that allows you to own the car at the end of your agreement without needing to pay a final balloon payment. Hire purchase or HP is one such agreement.

That said, there are real advantages to choosing balloon payment financing – we break these down below.

1. Lower monthly repayments

Other car finance agreements like Hire Purchase (HP) give you the option of owning the vehicle at the agreement’s end.

However, with HP, you don’t pay a final balloon payment. As such, you’ll face higher monthly repayments than you would with a car finance agreement that has a final balloon payment.

2. Fixed cost

A balloon payment is calculated based on your lender’s estimation of depreciation in your car’s value – the Guaranteed Minimum Future Value or Residual Value. This is a fixed cost – it won’t fluctuate throughout your car finance agreement, even if your car’s value changes.

Sometimes, finance companies may set the future value (its GMFV or RV) of your car too high, meaning it can depreciate in value more than expected, leading to a position of negative equity.

However, the balloon payment is a fixed cost. As such, if you find yourself in negative equity through no fault of your own (not breaching usage restrictions), you still won’t face any additional fees.

3. Potential for positive equity

Your car’s value may depreciate less than was predicted.

If your lender undervalues your car’s GMFV or RV, you could, therefore, find yourself in positive equity. This means that you find yourself at the end of an agreement with a vehicle that’s worth more than your finance company estimated.

You can then choose to make the final balloon payment and sell the car on for a profit. Alternatively, if you stay with the same finance company, you can put this positive equity towards the deposit on a new vehicle.

4. You get to own your vehicle!

If you love your car and want to keep it, you can!

With other car finance agreements like personal contract hire (PCH), you’re only leasing the car. So, you won’t own it outright at the end of your agreement.

If you’re keen on modifying your vehicle, you’ll want a car finance agreement that enables you to own the car outright at the contract’s end. Choosing an agreement with a final balloon payment is a great way of achieving this.

What’s more, if your car finance agreement has an optional balloon payment that you don’t want to make, you have two options available.

You could part-exchange the vehicle for a newer or different model or simply hand the keys back, as long as the vehicle is in good condition, in line with the contract terms and within the agreed mileage.

Disadvantages of a Balloon Payment

A car finance agreement with a balloon payment isn’t for everyone.

If you’re not interested in paying this final lump sum, there are plenty of car finance options with no balloon payment out there.

Don’t forget that if you’ve got questions about which car finance will best suit you, you can always contact our friendly team of Car Credit Specialists.

5.    Usage Restrictions

Car finance with a final balloon payment typically requires usage restrictions. You may be expected to keep under a certain mileage, and you are expected to return the car in good condition at the agreement’s end.

If you go over these usage restrictions, you’ll be penalised. This is because your lender will base your car’s depreciation value on these usage restrictions. Breaching them will impact the accuracy of this value, which can have financial ramifications.

6.    Not Ideal for Those With Lower Credit Scores

If your credit score is less than ideal, you’re unlikely to qualify for car finance agreements with a balloon payment.

Therefore an agreement without a balloon may be more suitable if your credit rating is low.

My Car Credit also offers poor credit car finance for individuals with less-than-perfect credit reports.

We combine a wide panel of trusted lenders with a sensible approach to help you find the right car finance agreement for your needs and circumstances.

Just because your credit score isn’t perfect, doesn’t mean you can’t find car finance – for example, options like PCP can make car finance more accessible thanks to lower monthly repayments.

7.    Not Optional for Lease Agreements

With PCP, the balloon payment is optional. However, this payment isn’t optional with a lease purchase agreement – you’ll have to pay the final lump sum.

8.    Expensive Final Payment

The balloon payment can be a hefty sum. You may not have access to the cash needed to make this payment.

However, you can always choose to refinance your balloon payment in this instance.

Our balloon payment finance allows you to break down the sum of the balloon payment into manageable monthly instalments. Use our free balloon payment finance calculator to find out more.

How do I Refinance My Balloon Payment?

Balloon payment finance is a way of refinancing your balloon payment.

In essence, you’ll be breaking down the lump sum into affordable monthly payments. You’ll also have an extended loan time, and you may be able to access better interest rates.

Wondering if you are eligible for My Car Credit car finance? Do the maths on your next car with our handy online calculator.

You can also use our online application form to kickstart your car finance journey. You’ll receive a no-obligation quote in minutes, and discover how we can help you find the car you want at a budget you can afford.