Thinking of buying a new car? If you use one of the online vehicle finance calculators to get an estimate* of your monthly instalments, you’ll notice that it allows you to try out various percentages of the total cost of the vehicle as a balloon payment. That “balloon payment” means an inflated final instalment.
But how does a balloon payment work?
If you buy a car for R400,000 with a balloon payment of 20%, your monthly instalments will be paying off a capital balance of R320,000, explains Lebo Gaoaketse, head of marketing and communication at WesBank. “The remaining R80,000 (the balloon payment) will be due at the end of your loan term – which is usually 72 months. But during this period, the interest portion of your monthly payment would still be calculated on the full price of the vehicle: R400,000.”
If you are able to settle the balloon amount at the end of the finance term, no additional interest is charged on the balloon amount, Gaoaketse adds.
It’s tempting to opt for that balloon payment. Our present bias tends to dominate – this is the psychological tendency to focus more on the present situation than the future when making decisions, such that we prioritise immediate rewards, even if that is ultimately less beneficial.
However, if you find the current instalment each month a challenge to repay at this point in time, it begs the question of how you would afford a final payment of many multiples of that amount. Our optimism bias – our tendency to overestimate our chances of success could also play a role. Perhaps we think, “I’ll be earning more money in five years’ time.”
The National Credit Act promotes responsible lending – you could see this as an attempt to protect us from ourselves and our biases. This means that the choice of a balloon payment is not necessarily fait accompli.
MFC, Nedbank Car Finance explains how they go about determining whether a potential customer may opt for this repayment structure: “MFC approves vehicle finance credit based on the consumer’s affordability, the asset and credibility/longevity of their source of income. Based on the aforementioned, the consumer would have to ‘qualify’ for a suitable percentage of their finance amount as the balloon amount, ensuring that they are able to afford the repayment at the end of term. The balloon amount will be calculated at the same rate as the normal instalments as it falls under one agreement.”
MFC says that the balloon payment is an option for consumers to enjoy an affordable premium during the repayment term. And the consumer could chip away at that balloon repayment in the meantime. MFC points out that “The consumer has the option of repaying the balloon – over and above the normal monthly instalments – during the repayment term whenever they have some extra cash, instead of waiting to pay the lump sum at the end of term.”
However, you could reach the end of the repayment term without having done this, only to face that hefty final payment. And even if you had met the affordability criteria, you may still find that you struggle to afford it. What then?
“If the consumer decides to keep the balloon amount till end of term,” says MFC, “they have the option of refinancing the full balloon amount and repaying it in instalments over a set term. The customer would be presented with different term options to refinance the balloon amount.”
And what happens if the customer fails to make payments on the refinanced balloon amount? “We will try to assist them through a collections process where they can make the necessary arrangements,” says MFC. “If they are unable to make the payment at all, we can take them through our assisted sales process, where they can sell the car to repay the loan. And if all else fails, we will opt for repossession of the car.”
* Note that this and other online calculators merely give an indication of the structure of your loan. Your application for a loan to finance the purchase of a vehicle is subject to an approval process with an accredited finance provider. The interest rate, for example, varies according to the “health” of your credit profile.
