A balloon payment (also called a residual value) is quite simply an amount of money that is still due after you’ve finished paying your monthly instalments. The goal of structuring a loan with a balloon payment is to make it more affordable on your current cash flow, making it very attractive.
They are ideal for both companies and private individuals who are facing a cash crunch in the short term but expect their liquidity to improve in the future. Essentially, a balloon payment allows you to make a lifestyle upgrade before your income can fully support it. There are many cases, then, where this approach can be highly beneficial; however, since the global economic crisis in ‘07 and ‘08, banks and borrowers have been a little more disinclined to simply blow up that balloon.
But, when you’re standing in that car lot, and a balloon option brings that nicer, fancier car within your monthly limit, it’s really hard to choose an option that won’t have a residual value in five, six or seven years. For this reason, many people are still driving around in cars that have a residual value looming.
Whilst we all hope our liquidity will improve within the next five years, it might actually decrease – especially with recent inflation increases. In some cases, we may lose our income altogether – making a balloon payment feel more like a noose than a pretty shiny thing, way off in the future.
If you’re sitting with a balloon payment, you should always have a plan to pay it off. Regardless of why you chose the structure, the sooner you can have a strategic approach to popping the balloon, or simply letting it go, the better.
Some people choose to trade-in their car every few years and work in the residual amount on their next finance plan through the trade-in. This is a helpful way to do it if you work towards taking a standard loan (without a balloon) on your next finance option, or if you start saving for a deposit.
If you’re working on that savings option, you might decide to use it to pay off your residual amount instead of trading in your car, which is also a helpful way to pop that balloon. If you find yourself with that increased liquidity, then you can use it to pay back the lifestyle upgrade sooner by increasing your monthly instalments.
At the end of the day, our financial products are becoming more complex in order to suit a wider variety of financial needs, but this makes it harder to know if we’re doing what’s best for our personal situation. If you need to review any recent or future financial choices, please feel free to get in touch!