What is a balloon payment on a car loan, and is it right for you?

A balloon payment lowers your regular car loan repayments by deferring part of the loan to a lump sum at the end. You'll pay more interest overall, so plan how you'll pay it.

A balloon payment is a lump sum you agree to pay at the end of a car loan, set as a percentage of the amount borrowed. It lowers your regular repayments, but you pay interest on the deferred amount for the whole term. It suits borrowers with a clear plan to pay the lump sum, such as trading in the car or refinancing.

When shopping for car finance, you may come across the option of adding a balloon payment to your loan.

It is a feature that gets attention because of the lower monthly repayments, but many borrowers misunderstand how it works.

How a balloon payment works

A balloon payment is a lump sum set aside at the end of a car loan term, typically representing a percentage of the original loan amount. You may also see it called a residual payment, particularly on business car finance and leases.

By deferring a portion of the principal to the end, the regular monthly repayments during the loan term are lower than they would be on a standard loan of the same amount. At the end of the term, the borrower pays the balloon amount outright, refinances it, or uses trade-in or private sale proceeds to settle it.

A worked example

The table below shows how different balloon amounts change repayments and total interest on the same loan.

A 30% balloon cuts the monthly repayment by about $204, but you pay around $2,750 more in interest and still owe $15,000 at the end. This example is for illustration only. It uses an assumed interest rate and excludes fees and charges, so it is not a quote or an offer of credit. Your rate, fees and repayments will depend on the lender and your circumstances. Check the comparison rate when comparing loans.

When a balloon payment may suit your situation

For business owners who want to hold onto their working capital, a balloon payment keeps monthly commitments lower while the vehicle remains in service. Business vehicles are often financed with a chattel mortgage, where a balloon is a common feature. Our business car loans page explains how these work.

For borrowers with irregular income such as quarterly bonuses, lower regular repayments can be supplemented with larger amounts directed toward the balloon payment when additional funds arrive, subject to lender policy on early repayments.

A balloon payment can also suit borrowers who prefer to upgrade their vehicle every few years rather than own one long-term. By setting the balloon amount close to the car’s forecast residual value at the end of the term, the trade-in or private sale proceeds can cover the lump sum. That lets the borrower use the car at reduced repayments and roll into a new vehicle when the term concludes.

The trade-offs

The most important thing to understand about a balloon payment is that interest accrues on the deferred amount throughout the length of the loan. This means the total interest paid over the life of a balloon loan is higher than on an equivalent loan without one. Lower monthly repayments do not mean a lower overall cost.

There is also residual value risk. If the car is worth less than the balloon amount when the term ends, the borrower has to cover the shortfall. Understanding the likely value of the vehicle at end of term before agreeing to a balloon figure is important. High kilometres, damage or a fall in used car prices can all leave you with a car worth less than you owe.

A larger balloon also leaves you with less equity during the loan. If you need to sell the car partway through the term, the payout figure may be higher than the sale price.

What are your options when the balloon falls due?

When the loan term ends, you’ll generally have four choices:

1. Pay it in full from savings or other funds, and own the car outright.
2. Refinance the balloon into a new car loan. This is a new credit application, so lenders will assess your finances and the car’s age and value at that time. Our guide to car loan refinancing explains what’s involved.
3. Sell or trade in the car and use the proceeds to pay the balloon. If you’re trading in, read our tips on how to trade in your car.
4. Ask your lender about extending or restructuring the loan, which some lenders may consider.

Start planning at least three to six months before the balloon is due. That gives you time to check the car’s value and compare refinance options if you need them.

It is not the right structure for everyone

A balloon payment works well when the borrower has a clear plan for how the lump sum will be handled at the end of the term. Without that plan, the end of the loan can create financial pressure that the lower monthly repayments did not prepare the borrower for.

If lower repayments are your main goal, compare a balloon with other approaches such as a longer loan term, a larger deposit or a lower rate. Our articles on ways to reduce your car loan payments and how much deposit you need for a car loan cover the alternatives. If you’re buying an older car, read why older cars are harder to finance first, because lenders limit the loan term on older vehicles. If a dealer is offering a balloon as part of a finance special, check the full deal first using our guide to 0% car finance deals.

A finance broker can help you compare car loans with and without a balloon payment across a range of lenders. Attain Loans is a finance broker in Melbourne’s west that compares car and business vehicle finance, subject to each lender’s assessment.

This article is general information only and doesn’t take into account your objectives, financial situation or needs. Consider whether it’s appropriate for you and speak with a licensed professional before making a decision.

Further questions

This is general information only and is subject to change at any given time. Your complete financial situation will need to be assessed before acceptance of any proposal or product.