When negotiation a car loan with your financier, one of the important decisions faced with is whether you wish to have a 'Residual Value' or 'Balloon Payment' on the loan.
These terms, which are essentially the same thing, are very often grossly misunderstood by consumers and deserve to be looked at closely: Having a Residual Value/Balloon Payment and the size of it affects the amount of your regular monthly repayments and allows you to pay a much lower installment during the first few years, while driving a car you wouldn't otherwise be able to afford.
Sounds like a great concept, but many car buyers have fallen victim to the less transparent negative aspects that such a loan entails.
How does it work? In simple terms, instead of spreading the full vehicle price over a normal finance period like four or five years, you defer a percentage, say 30%, of that lump sum to the end of your finance period.
This then allows for a much lower monthly installment during the normal finance period, but you still face the 30% 'balloon' payment (residual value) at the end of the loan term.
The balloon payment or residual amount can then be refinanced, or you have to pay in the outstanding lump sum by paying cash or selling the car! What happens when the balloon payment or residual value is due? There are generally a two options available when the Residual Value/Balloon Payment on a loan falls due: The Residual Value/Balloon Payment can either be paid in cash or, the borrower can refinance or 'roll over' their Residual Value/Balloon Payment into a new loan.
Rolling over the balloon payment is usually subject to approval by the bank.
Take note that refinancing the car could mean that you will be paying this car off over a longer period than you will likely want to be driving it.
The vehicle can also be sold and the proceeds are then used to pay the Residual Value/Balloon Payment and finalise the loan.
If you negotiated the loan at the maximum allowed residual value, the sales price would almost exactly match the amount required to settle the outstanding lump sum.
How big can the residual amount be? The maximum Residual Value/Balloon Payment, varies depending upon a range of factors specific to each financial institution, but generally includes the age of the vehicle, the loan term, and the borrower's financial profile.
Businesses use the term 'residual value' to describe the predicted amount an asset might be worth at the end of its useful life.
Similarly, car dealers use the auto industry standard Auto Dealers' Guide, to predict what a specific vehicle would be worth at the end of a determined period of time.
What are the restrictions involved in balloon payment / residual value loans? If you are considering taking out a vehicle loan with a balloon payment / residual value, there might be some limiting factors you need to know before you make your final decision.
These are mostly applicable to non-ownership residuals / leasing, but make yourself familiar with these: Mileage limits Because a car's mileage affects its resale value, balloon payment loans generally have an annual mileage limit, usually 15,000 to 25,000 kilometres per year.
If the allowed mileage is exceeded, a cost-per-km penalty usually applies.
Condition limits Make sure you are familiar with any possible restrictions to the normal wear and tear of the financed car.
Any abnormal damage that could further decrease a vehicle's resale value, would be subject to penalties.
At the end of the loan term / lease, it will be inspected and you'll have to pay for any damages.
You will also not be able to modify or upgrade the car in anyway if you a non-ownership balloon payment / lease.
These restrictions will not be applicable if you intend to purchase the vehicle.
Terminating the deal The ability to get out of a balloon payment / residual value loan is more difficult than settling a normal vehicle loan.
You might be responsible for more early termination charges stipulated on the contract.
Make sure you understand the penalties applicable, if any.
Insurance Comprehensive motor vehicle insurance is the only insurance that will be accepted with a balloon payment / residual loan.
Many car buyers are intrigued by finance deals that involve 'balloon payments' or 'residual values' because it could allow them to get finance for a car that they would otherwise not be able to afford.
Balloon payments are not always the best solution for everyone.
Do thorough research and carefully consider if a balloon payment is a wise choice for you.
These terms, which are essentially the same thing, are very often grossly misunderstood by consumers and deserve to be looked at closely: Having a Residual Value/Balloon Payment and the size of it affects the amount of your regular monthly repayments and allows you to pay a much lower installment during the first few years, while driving a car you wouldn't otherwise be able to afford.
Sounds like a great concept, but many car buyers have fallen victim to the less transparent negative aspects that such a loan entails.
How does it work? In simple terms, instead of spreading the full vehicle price over a normal finance period like four or five years, you defer a percentage, say 30%, of that lump sum to the end of your finance period.
This then allows for a much lower monthly installment during the normal finance period, but you still face the 30% 'balloon' payment (residual value) at the end of the loan term.
The balloon payment or residual amount can then be refinanced, or you have to pay in the outstanding lump sum by paying cash or selling the car! What happens when the balloon payment or residual value is due? There are generally a two options available when the Residual Value/Balloon Payment on a loan falls due: The Residual Value/Balloon Payment can either be paid in cash or, the borrower can refinance or 'roll over' their Residual Value/Balloon Payment into a new loan.
Rolling over the balloon payment is usually subject to approval by the bank.
Take note that refinancing the car could mean that you will be paying this car off over a longer period than you will likely want to be driving it.
The vehicle can also be sold and the proceeds are then used to pay the Residual Value/Balloon Payment and finalise the loan.
If you negotiated the loan at the maximum allowed residual value, the sales price would almost exactly match the amount required to settle the outstanding lump sum.
How big can the residual amount be? The maximum Residual Value/Balloon Payment, varies depending upon a range of factors specific to each financial institution, but generally includes the age of the vehicle, the loan term, and the borrower's financial profile.
Businesses use the term 'residual value' to describe the predicted amount an asset might be worth at the end of its useful life.
Similarly, car dealers use the auto industry standard Auto Dealers' Guide, to predict what a specific vehicle would be worth at the end of a determined period of time.
What are the restrictions involved in balloon payment / residual value loans? If you are considering taking out a vehicle loan with a balloon payment / residual value, there might be some limiting factors you need to know before you make your final decision.
These are mostly applicable to non-ownership residuals / leasing, but make yourself familiar with these: Mileage limits Because a car's mileage affects its resale value, balloon payment loans generally have an annual mileage limit, usually 15,000 to 25,000 kilometres per year.
If the allowed mileage is exceeded, a cost-per-km penalty usually applies.
Condition limits Make sure you are familiar with any possible restrictions to the normal wear and tear of the financed car.
Any abnormal damage that could further decrease a vehicle's resale value, would be subject to penalties.
At the end of the loan term / lease, it will be inspected and you'll have to pay for any damages.
You will also not be able to modify or upgrade the car in anyway if you a non-ownership balloon payment / lease.
These restrictions will not be applicable if you intend to purchase the vehicle.
Terminating the deal The ability to get out of a balloon payment / residual value loan is more difficult than settling a normal vehicle loan.
You might be responsible for more early termination charges stipulated on the contract.
Make sure you understand the penalties applicable, if any.
Insurance Comprehensive motor vehicle insurance is the only insurance that will be accepted with a balloon payment / residual loan.
Many car buyers are intrigued by finance deals that involve 'balloon payments' or 'residual values' because it could allow them to get finance for a car that they would otherwise not be able to afford.
Balloon payments are not always the best solution for everyone.
Do thorough research and carefully consider if a balloon payment is a wise choice for you.
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