Balloon Payments - The Definitive New Zealand Guide

Important: Before you take a balloon loan, understand how it works and the disadvantages of using this form of financing. Our guide explains everything you need to know, what to ask and alternatives to this highly risky form of car financing

Updated 19 February 2022

Important: Many people believe balloon payments offer an affordable option to purchase a luxury car. However, borrowing using a balloon payment model to buy a new luxury car often leads to financial hardship when large amount of money are due.

We take a view that balloon payments loans are dangerous, which is a sentiment shared by this Stuff.co.nz article published in March 2021.

Know This:

With most balloon payment agreements, you cannot hand the car back to the dealer and walk away if you don't want to (or cannot) make the balloon payment.
You will, most likely, be contractually liable to cover any loss from the selling of the vehicle to settle the balance owed.
This means that you may end up with no car and a debt owed to the dealer. You will be chased for this debt, which creates a most unpleasant situation and destroys your personal finances.
Many people fail to understand balloon payments and sign up anyway, as this real case example outlines.

We urge anyone to carefully read this guide and consult this informative Stuff column before proceeding. There are many options for car financing, and we take the view that balloon payment borrowing has more pros than cons.

To help you navigate balloon payments, our guide covers:

Looking for the best car finance offers? Our dedicated car finance guide has you covered.

What is a Balloon Payment Car Loan?

A balloon payment car loan is a unique way to finance a car. Overall, it works like a standard loan with fixed rates and fixed payments, but the similarities end there.

A balloon loan has lower payments because a lump sum (the balloon) is due at the end of the term. Meanwhile, the ongoing repayments are smaller (and often for a shorter period) because you finance less money. Rather than stretching the balance out over the entire term, you only stretch out a fraction of it – the rest is due upon maturity (inflated, like a balloon, and hence the name).

How much will the balloon payment be? How much you owe at maturity will be the amount you don't pay monthly. This can be negotiated with the lender when you take out the financing when you buy the car. But no matter how much or who you arrange finance with, the bottom line is the same - you owe a large amount upon maturity. For this reason alone, balloon payments can be risky.

Balloon Payments - An Example:

Mike borrows $80,000 to buy a luxury car for $100,000.
He puts down a $20,000 deposit and agrees to pay $1,000/month repayments for two years.
At the end of the two year period, a $60,000 balloon payment is due.
After two years of driving the car, Mike is forced to pay $60,000.
He can return the car, but he'll be liable for any shortfall in the sales price and what is owed. If the car is worth less than $60,000, Mike is in a situation of 'negative equity' with his car - standard ballon payment financing and luxury cards make this a very common situation.
While many balloon payment terms vary, understanding the terms and conditions are essential to avoid a financial mess.

Where do you get a Balloon Payment Car Loan?

Car finance companies don't commonly offer balloon payment car loans, nor do banks. Instead, balloon payments are mostly offered by dealers.

Why don't banks offer balloon payments?
Banks don't offer balloon payments because they're risky for customers - if you can't repay, you either lose the car, or the bank has to take legal action against you. Banks don't want this hassle, but dealer and manufacturer financing includes this as an option to sell more cars. The lower payment makes more borrowers eligible to buy a car, and the more buyers are willing to spend on a car. If you focus only on the monthly payment, it's easy to get trapped. Balloon payments are, for some car owners, a timebomb.

Balloon payment financing is offered by standard and luxury manufacturers and dealers.
Standard:

Honda
Holden
Nissan
Toyota (Choices Finance and Marine)

Luxury:

Who Should Consider Balloon Payments Financing?

We're conservative - there aren't too many positive situations where balloon payments are financially sensible. We believe that if you take out balloon financing just to have the lower repayments, you're only delaying the inevitable. You have to pay the balance at some point, and in this case, it's all at once.

But, some people may be in the rare situation that balloon payment financing makes sense. If you have the money set aside (and won't touch it) for the payoff, balloon payment financing can be an option. If you still own the car when the balloon payment is due, you can pay it off without any financial stress. If you want to sell the car before the balloon payment is due, you'll need to pay off the balance owed. Many people use the proceeds of a car sale to pay off the balance.

If you plan to keep the car only for a short time, balloon financing can make sense; your payment can keep your payments low while you own the car.

Our View - Balloon Payments: The Pros, Cons and Risks

The Pros:
Despite its risks, balloon payment car loans have some benefits:

Lower monthly payments: This is the most attractive part of balloon loans. Your monthly payments are lower, so the financing appears to be more affordable. If you have the balance owed set aside and sitting in a term deposit, you can benefit from balloon payment structures, providing the money set aside settles the final payment.
You earn interest on the money saved: While interest rates hover around record lows, the interest you earn by saving the money is often the driving factor for buyers (next to the lower payment). Typically, those who invest the balloon into a top savings account to earn money before eventually paying the balance to the lender.
You can negotiate what you pay: Just like negotiating the car's price, you can arrange a suitable balloon payment. You can work with the dealer to come up with an affordable ongoing repayment and balloon amount. Remember, if you lower the balloon amount, you increase your monthly payment.

The Cons:
As we've mentioned, there are plenty of downsides to the balloon payment car loan. These include:

You owe a large balance at once: In a few years, you'll owe the large balance left on the car loan. If you didn't set money aside monthly to save up for this time, you could find yourself in financial trouble.
Balloon payments may lengthen your car loan: If you can't pay the balloon amount off, you may be forced to refinance the debt. This means you take out another loan to pay off the balloon loan. While it gets you out of trouble with the lender, it puts you further into debt and lengthens the time to pay off the car loan.
You risk losing your car: If you can't pay the balloon payment and don't qualify to refinance, you could lose your car. After paying loan payments for the last few years, you could walk away empty-handed because you couldn't pay off the loan balance. As used cars depreciate, the amount you owe the lender may be more than the car's market value.
You'll pay more interest: Because you make lower payments throughout the loan's life, interest accumulates on the balance owed. Compared to a standard car loan, which ensures you repay principal alongside interest every month, balloon payment balances incur interest, but you don't repay the balance until the end of the term. While you wait, interest costs are added on.

Assessing the Risks:

We take the view that balloon payment car financing is highly risky. Firstly, how do you know you'll have the money to pay the loan off in full upon maturity? Secondly, no one can predict the future. You could have the best intentions to put the money away and keep it safe, but what if you have urgent needs?
Remember, you could lose your job, fall ill, or have financial issues which take priority over keeping money aside for a balloon payment.
It's risky to take balloon payment financing. Many people assume it's 'better' because of the lower ongoing repayments, but, in many cases, it's not.
Owing $10,000 or even $50,000 is a significant liability to carry, and while the balance owed is 'interest-free', financing the balloon can have consequences. With record house prices, high rents and flat job security, taking on a balloon payment liability needs to be carefully considered.

How do you Pay a Balloon Payment Balance?

The idea of the balloon payment loan is you make the lower (mostly interest) payments monthly and then pay off the balance upon maturity. If you saved money or already had the money put aside, you make a lump sum payment and satisfy the loan. You keep the car and own it outright.

If you don't have the money, you must apply to refinance the loan with another lender. You can apply for a secured loan (using your car as collateral) or an unsecured loan (no collateral) to pay off the balloon loan. You'll need a strong credit history, a stable income, and proof you can afford the loan.

If you qualify, the new loan pays off the balloon loan, and you make payments to the new lender. This extends your loan and costs you more in interest. You will, most likely, pay loan arrangement fees. Consequently, you not only paid interest on the balloon loan, but you'll pay interest on the new loan too. For these reasons, balloon payments are often expensive and high risk (unless you have the required sum of money set aside to pay off the balance).

Alternatives to Balloon Payment Loans

If a balloon loan doesn't seem right for you (it's not right for many), consider the alternatives:

Buy a cheaper car – If you prefer lower repayments, look at more affordable cars. You can get a lower payment with a less expensive car. We take the view that balloon payment loans artificially decrease ongoing payments and encourage people to live outside their means.
Arrange competitive car financing - our car finance guide lists many lenders who offer secured loans with interest rates as low as 5.50%. This is significantly more affordable than any balloon payment arrangement, and lets you repay the balance owed consistently over a fixed period (usually 2, 3, 4 or 5 years).
Lease a car – If you aren't sure how long you want to keep a car or you don't want the risk of a balloon payment, leasing a car is a popular option. Our vehicle leasing guide has more details. You'll likely have lower payments by leasing.
Pay cash upfront – If you can't commit to making your payments on time each month, consider waiting until you can pay cash for a (used) car. This avoids the risk of repossession that comes with any secured car loan. Our guide to buying a used car has more details.

Balloon Payments - Frequently Asked Questions

Know this first: Balloon payments come in various forms. Before agreeing to anything, please read the details very carefully so that you know your obligations. The liability (i.e. debt) created from balloon payments is significant, and we can't see any definitive reason to enter into such an arrangement unless it's significantly more cost effective than alternative financing.

Is a balloon payment car loan a good idea?

Our view is conservative - we believe that the only people who should consider such financing are those with the money put aside for the full amount (and won't spend it before it's due). If you still own the car when the payment is due, you can pay it. Otherwise, you put yourself at risk of being unable to afford the full amount and losing the car.

How can you avoid a balloon payment loan?

There are many alternatives to balloon payment finances - you can pay a downpayment (and arrange car financing), trade-in or pay in cash. If you arrange financing, the money you put down decreases your loan amount, which reduces your ongoing repayments. While balloon payments are due at the end of a term, a down payment is paid upfront and eliminates the risk of not having enough money for a balloon payment later. You can then manage the ongoing repayments as they fall due.

Are balloon payments fixed?

Yes - you'll receive a fixed interest rate and payment for the duration of the loan. For example, if you have a 3-year balloon loan, your payments are fixed for three years. At the end of three years, the remaining balance (plus interest) is due.

How do you get rid of a balloon payment?

You get rid of a balloon payment by paying it off in full upon maturity. If you can't, you may refinance the loan, but only if you qualify. If you think you'll need to refinance, your credit history needs to be strong, and you'll need to stabilise your income and keep your debts to a minimum to qualify for the new loan.

Can you lose your car if you don't make a balloon payment?

Yes, even if you make your payments throughout the term and cannot make your final balloon payment, the lender could take possession of your car. This is the major reason why balloon loans are very risky unless you have the money set aside and want to earn the interest yourself until it's due.

Can you switch from a balloon payment to monthly car finance repayments?

Yes, but if this is a risk, it's better to organise refinancing in advance of a balloon payment falling due. Our guide to car refinancing has more information about how to arrange a switch.

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