Vehicle Finance And Balloon Payments

It’s a popular way to sell vehicles these days; the balloon payment. The sales and marketing will tell you that it brings down your monthly installments and at the end of the finance term, the dealer will buy back your car to cover that balloon payment (guaranteed, terms and conditions apply) or you just refinance/settle that outstanding amount. Sound good?

This payment is also known as a bullet payment: because it’s like a bullet to the head. Sound harsh? Not when you know what’s really going on in the maths. And keep in mind, the residual offer is also made available to folk who are “high risk” or simply cannot afford the regular payment. In other words, people who are already financially marginalised. Let’s have a look see…

Note: numbers have been rounded to make the reading easier…

The list price on a vehicle is R330 000. Terms are over 60 months. Interest rate: 11.5%. On a regular loan, you can expect to pay back R7200/month. Once you’re done paying for the car, you’ve paid back R435 453.63 (or financed R105 500 in interest over the 5 years). Ha, you think that’s bad?

Let’s apply a 30% balloon payment to the same offer. Your balloon payment is R99 000. Your monthly payment is now down (the “good” news) to R6 000/month. Over the term, at that repayment, you’ve paid back R361 800 (or what might look like R31 800 in interest). Wow. Sounds great! BUT, you still owe R99 000. Now even if you paid off that R99 000 in one go, you would have paid R130 800 extra for the same car. So where does it all add up…?

That R99 000 payment at the end of the term is discounted back to today’s value (at the deal’s terms and interest rates) to a value of R55 860. The loan that you actually end up applying for is NOT R330 000 – R99 000. It is in fact R330 000 – R55 860, a value of R274 140. That’s why your repayment is lower- but not that low. That R99 000 represents a “discount” you get today but you still pay interest on it until you pay it off. Effectively, you’re financing 2 loans. You have actually financed R87 600 in interest (compare that to R105k on the traditional loan)

One for R274 140 at R6 000/month, another for R55 860, except that in case, the monthly payment is deferred in lieu of paying the whole loan off in one go at the end. Still sound good? Of course, if you have the extra R1200/month lying about, pay it in, but you might need to stipulate wether this is a payment towards interest, capital or the residual. Getting complicated?

Now, unless you have that amount lying around after 5 years of paying a premium, you’re probably going to need to refinance that R99 000. The terms and interest of that loan don’t exist today and still have to be negotiated. Let’s assume you manage to refinance that R99 000 on the same terms (unlikely), that’s another 5 years at R2 200/month for a grand total of R130 600.

In all, your R330 000 car, with a 30% residual refinanced, now costs you R361 800 + R130 600 = R492 400 over 10 years. The traditional loan is R435 500 over 5 years.

Now, just looking at the whole deal, you can decide for yourself wether that’s worth it or not. Depending on where you’re investing, spending, saving, it might actually be a worthwhile avenue. Or it might not.

Just keep in mind:
* you’re paying off two loans when you opt for a residual value
* the residual amount represents a discount you receive today that’s already been compounded with interest
* you’re effectively applying for finance at the list price less the discounted price
* the dynamics of the interest on the residual are hidden from view

Happy financing!