Car Clinic: Buying With Balloon Payments?

Car Clinic: Buying With Balloon Payments?
 

Question:

I am a first time buyer, and I’m thinking of buying a Volkswagen Polo GTI. Will it be advisable to buy it on balloon payment?

Kagisho Max

Answer:

Vehicle loans with a residual value (balloon payment) have become popular, especially with younger buyers. A residual value makes the regular monthly instalments during the term of the loan more affordable. As an example, if you take out a 72 month loan with a 25% residual value to buy a car costing R300 000, it means that the monthly instalment will be calculated on R225 000 only. Repayment of the other R75 000 (the 25% balloon payment) will be deferred to the end of the loan term, six years from now.

The advantage of such an arrangement is that the residual value does not run up interest during the six years, it’s like an interest free component of the loan, repayable in a lump sum, six years from now.Buyers who are unable to save up enough money to meet the balloon payment when it falls due have two possible escape routes: the bank may agree to “roll over” the residual value into a new (interest bearing) loan to spread the balloon payment over a further year or two, or you can trade in the vehicle before the residual amount becomes payable.In the latter case, the balloon payment will first be deducted from the trade in amount to finalise the loan,and the rest of the trade in value can be used for a deposit on a new car, provided the trade in value exceeds the residual value.

A disadvantage of a balloon payment (if you use the trade in option) is that you are never free of car debt. Furthermore, there is always a measure of uncertainty whether the eventual trade in value will cover the balloon payment.Loans of this type sometimes involve early termination penalties, which come into play if you wish to settle the loan before the full term has expired. This can happen if you wish to trade in the car when the maintenance plan lapses. A residual value loan may be advantageous if you intend to keep the car for at least four years. It is not recommended if you prefer to have a new car every two years.

-Gerrit Burger