Most of us don't know the dangers of a balloon payment car loan and what we should be aware of prior to signing our loan papers and taking our new vehicle home.
What is a Balloon Car Loan?
First you need to understand exactly what a balloon loan is. Balloon auto loans are designed so that when the loan term, or length of the loan, is finished the car is not paid in full. Instead you make one last, large, balloon payment to complete the terms of your loan. Until this payment is made you vehicle is not paid in full. Balloon loans keep your monthly payments lower. In addition these payments are mostly for the interest. When your balloon payment comes due you are usually paying off the principal of the loan. So what are the dangers?
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Keep Your Payments Low
A balloon loan is a good option if you absolutely need to keep your monthly payments low knowing that towards the end of the loan you will have the money to pay off the balance. Additionally balloon loans are an option for those people who absolutely need a new car but have no money for a down payment. Still you need to be sure that at the completion of your loan, 3 to 5 years from now, that you are driving a vehicle that is worth paying off. Paying $7,000 for a vehicle you no longer want isn't worth that amount can be difficult to deal with.
Typical balloon car loan schedule
Plan in Advance
Aside from having a car you want to pay a large sum of money for you really need to plan for the balloon payment in advance. Saving monthly, or investing some money in order to make the balloon payment is extremely important. You also need to consider that refinancing a balloon loan can be difficult making your decision that much more important. It may be possible to extend the length of your balloon loan at the end of the term but it is not guaranteed. If you do refinance you could end up extending the amount of time you are paying on your new car from 3 to 5 years to possibly 5 to 7 years, or even longer.
Not having the money for your balloon payment at the end of the loan is really the worst-case scenario for the lender. If you miss your payment, cannot make arrangements, or cannot refinance you may lose the car even after you paid the interest for all those years. Even if you have the option to buy the car back you still have to come up with the principal to do so. Under a normal loan if you lost your car towards the end of the term you could buy it back for far less than you would if you had a balloon loan.
Dangers of a Balloon Car Loan
There are many concerns you should have about taking out a balloon payment car loan:
- The first concern should be obvious, but many dismiss or overlook it. It is highly likely that you will not be in a better financial position in 3 to 5 years, as much as you hope or would like to think that you will be.
- You need to carefully consider what you will do if you are unable to refinance your car at a better rate and with better terms. How will you pay that loan off? You will still be obligated for the balloon payment. Are you prepared to let the car go? What will you do for transportation? Not making that balloon payment will damage your credit score.
- Another concern is that since you are paying only interest on the loan through the end of the loan period, you will likely owe more on the vehicle that it is worth. This will cause you great difficulty in selling for the amount you owe or refinancing the loan.
- Before taking on a balloon loan for a car purchase, carefully consider the value of the car, the expected value in two or three years when the balloon car payment will be due, and how much you are willing to sacrifice to own the vehicle. In many cases, a balloon loan is not the right financing option, and simply allows you to incur more debt that you can really afford.
- See what kind of interest rates you can get >>
Benefits of a Balloon Car Loan
Here are some of the benefits of getting a Balloon Car Loan:
- A balloon payment car loan buys time: The lower payments during the loan term allow for the borrower to collect the cash due to pay off the entire debt. Some scenarios include other investments that may mature during the loan term, or changes in income that will allow the borrower to pay off the entire debt.
- A balloon payment car loan allows for a "sale option": If the borrower holds the title in the interim, he or she has the option of selling off the vehicle and using the resulting cash to pay off the loan. It's important to talk about this situation when taking out a balloon payment car loan, as liens or other types of restrictions may prevent or delay resale.
- A balloon payment car loan is essentially "lump credit": The lender carries much more of the deficit throughout the term of the auto loan, leaving more cash in the hands of the borrower.
- A balloon payment car loan generally offers a lower chance of repossession: Because of the fact that the loan payments are smaller than they would be with a different type of loan, there is a lower chance that repossession agents will show up at the door looking to take a vehicle.
- A balloon payment car loan generally offers fixed rates: For any unsecured car loan, the norm is for the loan to carry fixed rates of interest, so that the borrower knows what total amount they will eventually pay and does not have to worry about changes in the interest rate of the loan due to fluctuations in the market.
- See what kind of interest rates you can get >>
Requirements for a Balloon Car Loan
There are two main requirements for getting a balloon car loan:
- In order to qualify for a balloon loan, you need to have a regular income - in other words, have proof that you are employed and can make payments on the car.
- You need to have a solid credit rating, although the exact number is flexible with some lenders.
How to Compare Balloon Car Loans
It is important to take the time to compare a balloon car loan against different loans. You do this to make sure you are getting the best deal possible. You are also working with your current financial means to help you get over some rough spots or finding the best deal for you overall. Taking the time to compare these types of car loans is very important, but knowing how to compare the balloon payment car loans is also important.
1. Understand the End Number
Every balloon payment car loan has a final number. This is the amount you will be making on your final payment. A balloon payment is a type of payment that keeps pushing off some of the amount until the end payment. You should understand what that number is going to be. There are two ways to do that:
- Ask the lender what the rate of interest is going to be?
- What type of loan is it? Are you going to pay more at the end or are you going to pay less?
2. Check out the Monthly Payment
Knowing you can afford the payment is also something you should know. During the course of the payment the amount you pay each month could rise making the last payment much larger at the end than when it started. Check this out by calculating the interest rate, and the total cost of what you are paying off.
3. Compare the Interest Rates
Knowing which interest rates you are going to be paying is crucial to the amount you are paying in the end. Compare rates and compare the rates of how the loans will increase, or decrease over time. Check each lender and ask for a detailed amortization (or amount of projected time it would take to pay off the debt) of the loan. This will show you exactly where you will stand each month.
- First, you can have a low interest rate which will make for a low initial payment that will rise over time for a higher ending payment.
- Second, you can do the opposite. You can start with a higher interest rate which gives you a larger initial payment, but decreases over time.
- See what kind of interest rates you can get >>
Balloon loans can be extremely beneficial to the right people but you should be aware of the dangers. More so than any other loan you need to have a plan to take care of the balloon payment ahead of time. With careful planning and proper research you may be able to avoid the dangers of a balloon loan.
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