Beware the pop of balloon payments!

Published on 18th July, 2022 at 03:13 pm

Driving off in a shiny new set of wheels is exciting, but make sure the joy lasts – for your trips and your finances – by fully understanding your vehicle finance agreement, especially if it includes a balloon payment. The experts share how.

Balloon payments in a nutshell

For some of life’s big purchases, like buying a vehicle or a property, you may be expected to pay a deposit after having qualified for financing from the financial institution that’s approved a loan in your favour. This is paid upfront at the start of the financing agreement.

A balloon payment works in much a similar way, but is a bit more enticing in that, instead of requiring you to save up for a deposit before you drive off in those snazzy new wheels, you only have to pay it at the end of your loan term. This is a balloon payment. “The amount needs to be paid before ownership will pass to you, the buyer,” explains Janson Ponting, sales director at WeBuyCars. “When you buy with a deposit, you save interest, but when you buy with a balloon payment, it will acquire interest over the term,” he adds.

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How balloon payments can help

Balloon payments are the best friend of instant gratification: instead of saving up for a deposit on a new ride, dealerships offer the option to hand over the keys to said ride, and charge lower instalments for your premiums, which makes sense if you urgently need a ride and could do with easier cash flow, says Ponting. But again, the money you’re saving on those instalments needs to be paid somewhere, which is why balloon payments can only help if you’re diligent enough to save up that capital during your loan term…

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… Which brings us to their pitfalls

Well-planned financial goals, and the journey getting to them, are characterised by diligently saving towards something that has incentivised you to stay the course. When there’s anything from a new dress or wristwatch, to your children’s schooling or your retirement, at the end of the savings journey, you can reflect once you’ve reached the destination with the extra satisfaction that it took sacrifice and perseverance to get there.

Balloon payments turn this on its head. They put the prize at the start of the journey, on the premise that you can save money on your instalments – provided that you pay that balloon payment lump sum at the end. Naturally, those who remember and stick to saving up for it are more the exception than the rule, as Jyoti Gopee, a financial planner at Pinnacle BlueStar, authorised by Sanlam, shares: “We often see that clients did not save the premium towards the balloon that they should have been. At the end of the financing term, they forget that they’re supposed to have had that amount of capital to pay back the dealership.”

So, then what?

Here’s where the money gets messy, and the first markers of a debt spiral begin to rear their head. “Too often we see clients doing one of two things,” says Gopee. “They either refinance the balloon payment, or they change their vehicle.”

Under the guise of an upgrade, the incentive the dealership would offer is that you, the buyer, don’t have to pay that balloon payment because they’ve financed it into the second vehicle agreement. “Plus, you don’t have to worry about the service plan, because if it’s a new model, the service plan starts from year one again, instead of being on year five on the existing vehicle,” explains Gopee. This sounds enticing, but it doesn’t eliminate the reality: that you’re growing your liability and perhaps not realising it.

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Offered a balloon payment? Here’s what to do

“As a rule, when clients are exploring the option of taking out vehicle finance that includes a balloon payment, I discourage it,” Gopee says, citing the risks discussed here.

Besides the knowing that you’ll need a lump sum saved up at the end of your finance term, think about the unknowns. What’s worse than having a car for a month into the financing agreement, and getting into fender bender, and then having to not only pay for the instalments and panel beater, but still continue to save towards the balloon payment? The joy of having new wheels is quickly drained and replaced with avoidable money stress.

With that said, Ponting recommends taking heed of the following when signing an agreement with a balloon payment:

• You might be able to refinance the balloon, but this is not always possible, and you have no guarantee that there will be enough equity in the vehicle to refinance the balloon payment.
• You are paying more interest with a lower monthly instalment over the term.

Help! I’m already locked into a balloon payment!

Take a deep breath and don’t panic. The best thing you can do, if you aren’t already, is save towards that balloon payment. “If you know in five years’ time you need R50 000, you already need to have a strategy in place where there’s a fixed saving that’s going to take place on a monthly basis to meet that need,” says Gopee. “If you’ve opted for a hire purchase agreement with balloon payment, [ideally] from day one of signature, as you sign that agreement, you need to go sign and make sure you’ve confirmed a recurring savings or investment plan based on trusted advice to make sure the end outcome will safely cover that balloon at the end of the term,” she concludes.

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