Balloon Payment Auto Loan: A Definition
A balloon payment auto loan affords a purchaser many of the benefits of a traditional auto loan while also offering lower monthly payments. Monthly payments are lower because balloon loans often carry lower interest rates and require the borrower to repay a smaller amount each month when compared to a traditional auto loan.
Similar to a lease, a balloon payment amortizes the loan over a longer term than one will make monthly installment payments for. For example, a balloon loan may require the purchaser to make 60 monthly payments on a loan that is amortized over 120 months. When the 60 month term ends, there is still the equivalent of 60 payments remaining, equal to 50% of the vehicle's original selling price. The owner may choose to pay off the remaining balance of 50% or, alternatively, may choose to refinance the remaining 50% balance subject to lender approval.
For example, if the purchaser is considering a vehicle with a price of $50,000 that is amortized over 120 months, the pre-interest monthly payment would be $416.67 for the 60 month installment term. After 60 installment payments the owner may payoff the remaining balance of $25,000 or refinance the remaining balance through a local lender or a car dealership.
A balloon payment auto loan allows the purchaser to drive a more expensive vehicle than they could with a normal finance contract. However, one must be careful to budget for the balloon payment. The owner may choose to invest in high-yield savings accounts, certificates of deposit and the like to help grow their savings to pay the final balloon payment. If an owner plans to keep a vehicle for a prolonged period of time, refinancing is also a good option.
While balloon payment auto loans can provide lower monthly payments, it is important to remember that the cost of the balloon payment still makes the lifetime cost of a balloon loan the same as a traditional finance contract.