A balloon payment auto loan affords a purchaser many of the benefits of a traditional auto loan while also offering lower monthly payments. The payments are lower because balloon loans often carry lower interest rates and require the borrower to repay a smaller amount each month when compared to a traditional auto loan.
It is an attractive option nowadays for those buying a new car. There are many advantages and disadvantages to this type of loan compared to others out there.
Similar to a lease, a balloon payment amortizes the loan over a longer term than one will make monthly installment payments for. For example, a balloon loan may require the purchaser to make 60 monthly payments on a loan that is amortized over 120 months. When the 60 month term ends, there is still the equivalent of 60 payments remaining, equal to 50 percent of the vehicle's original selling price. The owner may choose to pay off the remaining balance of 50 percent or, alternatively, may choose to refinance the remaining 50 percent balance subject to lender approval.
It keeps your monthly payments very low. Some loans that are big enough are actually structured where the interest payment is the monthly payment. The principal would then be the balloon payment.
Another advantage of balloon payments is that there is no down payment required most of the time. Many people want to buy a new car but often can't because they don't have enough for a down payment. This option makes the dream possible. You also can save that down payment to add it onto the balloon payment in the end, giving you times to accrue the investment. Or you can also use that for other things you may have not been able to pay off, such as a credit card debt.
With many balloon payments, you can also refinance at the end of the term. This raises your monthly payments but you wouldn't be on the hook for thousands of dollars’ worth of a balloon payment at the end of the period.
There are some drawbacks to this type of loan. First, before choosing this option, one should exhaust their other options. A balloon payment sounds great in theory. However, one has to be very good with financial management to really get it to work smoothly. It may sound like a good idea to pay $10,000 in the span of five years--sounds simple. However if you don't plan for it, it can be a bad day when that term finally matures. If you can't make the balloon payment, refinancing is not always an option--although it usually is. With this, the car loan interest rate will go up as well as your payments. Then you will have paid interest twice, much more than the original principal amount for the car.
Risking non-payment puts you at risk of losing your car, even after you've been paying previously for it.
Balloon auto loans are good options for some but you must heed the risks and dangers involved. If you are committed to the loan and save up for that day where the balloon payment is due, you should be fine.