How do you know if a car finance agreement with a balloon payment is right for you? The first step is to understand the advantages and disadvantages of a balloon payment. Read on as we look at 4 advantages and 4 potential disadvantages.

What is a balloon payment?

A balloon payment is the one-off lump sum, plus an option to purchase and possible admin fees, that you can pay at the end of certain car finance agreements like PCP. By making this payment, you’ll own the car outright.

Balloon payments aren’t obligatory with PCP – at the end of your finance agreement, you can always hand the car back, or choose another finance agreement on a different car.

Any balloon payment is calculated on the expected depreciation of your car (also known 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

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.

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 get your car’s value (its GMFV or RV) wrong. It can depreciate in value more than expected, meaning you’re in 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.

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.

You get to own your vehicle!

If you love your car and want to keep it, you can! Otherwise you have two further options available to you. 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

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.

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.

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.

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 choose to refinance your balloon payment in this instance.

How do I refinance my balloon payment?

With balloon payment finance, you’re refinancing your balloon payment. This allows you to break 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.

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