Balloon payments: A vehicle scheme that could burst your financial bubble

Remember that feeling when you were a kid and stood watching as your shiny balloon slipped out of your hand and vanished into the sky. The adult version is buying a car because you must have it, and then finding that your payments are threatening to go up, up and away.

Like that childhood balloon, a car balloon payment can cause heartache. It’s too easy to take advantage of the short-term benefits and ignore the fact that there is going to be accounting somewhere down the line.

Unfortunately, there usually is not a dad or mom around to pat you on the head and say, “Don’t worry, I’ll get you another one”.

What is a balloon payment?

Looking for a definition of a balloon payment will unearth something like this: “A balloon payment is a deferred lump sum payment at the end of a car finance agreement”.

It sounds so benign that it is hard to see that it is a double-edged sword. The bad thing about swords of this type is that it is incredibly easy to cut yourself.  

Given the see-sawing value of the rand, our inflation, VAT rate and lending rates, it is safe to predict that the price of the car you want to buy in 2020 is going to rise.

Common sense also dictates that the equivalent model in 2005 will be stunningly expensive, and that car just looks so good.

What you think as you look at the object of your desire

• I want this car (at this point you should be hitting the dealership door).
• I know that I can’t afford it, but a balloon payment will let me pay the bit extra. Who knows what the 2025 model will cost? (You are now passing the point of rational thought.)
• The balloon payment will reduce the size of my monthly instalment. (You are now at the top of the slippery slope.)
• With the money I save on instalments, I will be able to put the balance in a savings account to pay the balloon settlement (Hah, hah.)
• I will get good increases and can use my extra pay and bonuses to easily handle the balloon (ever heard of COVID-19 and recessions, kid?).
• The dealer says he has run the numbers, and I will get approval (isn’t he the guy whose commission is going towards a family holiday?).
• I can refinance if I must. (The closest you have come to the truth.)

What you should be thinking

• It will be much cheaper to stay with what I can afford.
• If I need to refinance the balloon payment, will I be happy to keep using the car for longer?
• Doesn’t refinancing mean that I must pay more interest?
• Hang on; the car loses value over time. What will the vehicle be worth when the balloon needs to be paid?
• If I can’t afford the balloon and the dealer doesn’t want to trade the car in, I may have to sell the car. What if I don’t get enough out to cover the balloon payment?

This example from Wesbank puts the debate into perspective:

• Purchase price of vehicle:      R240,000
• Interest rate:                           11.5%
• Period:                                    60 months
• Balloon payment (20%):         R48,000
• Monthly repayment:                R4,739.58

• End of finance period total:    R284 374.84
• Plus balloon:                           R48,000

TOTAL:                                    R332 374.84

Cutting to the chase, after 60 months of payments, you have a single amount that is the equivalent of just over ten instalments still outstanding.

This is the point where the next thoughts pop up in your head. They go like this:

• “Hmm, perhaps the dealer will trade in my car, offset the balloon against what he will pay me for the old car and then find a way to add the surplus owing onto the price of the car I now have to buy from him. (Dealer smiles, thinks of his next holiday in Mauritius, or will it be Thailand?)

What do people who finance cars think? This gem from a Hippo site quoting Wesbank:

“WesBank advises that consumers steer clear of balloon payments since it may seem an attractive option at first but will only boil down to increased debt in the long run.

“Buyers end up spending a lot more on the interest over the longer period of the loan, and a balloon payment, also subject to interest, could attract even more charges should a buyer decide to refinance.”

The coup de grace: “Wesbank encourages car buyers to settle for a cheaper vehicle at the shortest repayment period possible and to pay a deposit on the vehicle.”

At least 20% of buyers disagree with the bank and go for a balloon payment anyway. Good luck, dudes.