Before you sign your loan papers and take your new car home, it's important to understand the benefits and dangers of a balloon payment car loan.
What Is a Balloon Car Loan?
Balloon auto loans are structured to reduce monthly payments by shifting a significant portion of your loan to one final payment. So you might cut each payment by $100 and add a final installment of $5,000 at the end of the loan's term. Since lenders front-load interest, when your balloon payment comes due you are usually paying off the principal of the loan.
See what kind of interest rates you can get >>
Benefits of a Balloon Car Loan
So what are the benefits of taking on this type of loan, and are there any dangers?
Here are some of the benefits of getting a balloon car loan:
- A balloon payment car loan buys you time: The lower payments during the loan term allow you 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 allow you to pay off the entire debt.
- A balloon payment car loan allows for a sale option: You may have the option of selling the vehicle and using the resulting cash to pay off the loan. However, you might still need to repay some money to the lender depending on your agreement. 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 a lump credit: The lender carries much more of the deficit throughout the term of the auto loan, leaving more cash in your hands.
- A balloon payment car loan may offer a lower chance of repossession: Because the loan payments are typically smaller than they would be with a different type of loan, there can be a lower chance that a recovery company is going to show up looking to take a vehicle.
- Balloon loans keep your payment low: A balloon loan is a good option if you need to keep your monthly payments low and know you'll have the money to pay it off towards the end of the term. Additionally, balloon loans are an option for those people who need a new car but have little or no money for a down payment.
Dangers of a Balloon Car Loan
Even with the benefits you could get out of a balloon payment car loan, there are a few dangers you have to watch for with this type of loan:
- What happens if you're unable to make your final payment? Can you refinance your car at a better rate or with a longer loan term? Are you prepared to let the vehicle go? What are you doing for transportation if you can't keep this car? Carefully consider your options before taking on a balloon car loan.
- Not making that balloon payment will damage your credit score. Missed payments harm your credit score – in some cases significantly. Payment history is the biggest part of your credit score, so missing a payment as large as your final auto loan payment is likely to do some serious damage.
- You're mostly paying interest on the loan until your balloon payment comes due. In this case, you may end up owing more on the vehicle than it's worth, which puts you in a negative equity situation. It could be harder to sell the car for the amount you owe or refinance the loan when you're upside down.
- 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 than you can really afford.
Requirements for a Balloon Car Loan
There are two main requirements for getting a balloon car loan:
- 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. This means you may not qualify if you're a bad credit borrower.
How to Compare Balloon Car Loans
It’s important to take the time to compare a balloon car loan against different loans to make sure you are getting the best deal possible. Taking the time to compare different types of car loans is very important.
But, knowing how to compare the balloon payment car loans is also important. Here are the steps to comparing balloon loan offers:
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. You should understand what that number’s going to be, so ask.
Check out the Monthly Payment
Knowing you can afford the payment is also something you should know. During the loan, the amount you pay each month could rise, making later payments much larger than when they started. Check this out by calculating the interest rate, and the total cost of what you are paying off.
Compare the Interest Rates
Knowing which interest rates you are going to be paying is crucial to your bottom-line cost. 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.
Plan in Advance
It's important to plan for your balloon payment in advance. Save monthly, or invest with this in mind. You should also know that refinancing a balloon loan can be difficult. It may be possible to extend the length of your balloon loan at the end of the term, but that isn't guaranteed. And if you do refinance, you might end up stretching your original three- to five-year loan term to 84 months (that's eight years!), or even longer.
Not having the money for your balloon payment at the end of the loan is a worst-case scenario for the lender — and you. If you miss your payment, can't make arrangements, or can’t refinance, you may lose the car even after you've paid the interest for all those years.
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 could with a balloon loan.
Balloon loans can be extremely beneficial to the right customer, 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 any drawbacks.
Not Sure What Type of Loan You Might Qualify for?
If you're looking for a new car loan, start by shopping for the right vehicle here.
If you're worried about your credit situation holding you back – don't be. Auto loans are out there for borrowers that struggle with tarnished credit. You just have to work with the right lender, and we want to help.
Let CarsDirect take the hassle out of finding a local special finance dealership that's signed up with the lenders you're looking for. Get started now by filling out our fast, free, no-obligation car loan request form.