A balloon payment, sometimes called a residual, is a lump sum you owe at the end of the loan after making smaller regular repayments along the way. It is common on vehicle and equipment finance, and it is easy to see why it appeals: the monthly figure drops.
The question worth asking is what that lower figure costs you.
How a balloon works
Normally, your repayments are sized so the balance reaches zero by the last one. With a balloon, the repayments are sized so the balance reaches the balloon amount instead. That final amount is then paid out in one go, refinanced, or settled by selling the asset.
Because you are not paying down as much principal each month, you carry a higher balance for longer, and interest is charged on that higher balance.
A worked example
Suppose you borrow $45,000 over five years at an illustrative 8% a year.
With no balloon: the monthly repayment is $912.44. Over 60 months you repay about $54,746, of which about $9,746 is interest.
With a $13,500 balloon (30% of the amount): the monthly repayment falls to $728.71. Over 60 months you pay about $43,723, and then the $13,500 balloon on top. In total you pay about $57,223, meaning roughly $12,222 is interest. (Figures are rounded to the nearest dollar because lenders round repayments in different ways.)
| No balloon | 30% balloon | |
|---|---|---|
| Monthly repayment | $912.44 | $728.71 |
| Balloon at end | $0 | $13,500 |
| Total interest (approx.) | $9,746 | $12,222 |
The balloon reduces your monthly repayment by $183.73, which is a genuine relief on a tight budget. The price is roughly $2,476 more in interest over the term, and a $13,500 bill that must be dealt with on a specific date.
Why the interest is higher
For the first few years, the balance in the balloon loan is higher than in the standard loan at every point in time. An 8% rate on a bigger balance means more interest each month. The extra interest is not a hidden fee; it is simply the result of owing more for longer.
Questions to ask before choosing one
- How will I pay the balloon? From savings, from selling the asset, or by refinancing? Refinancing depends on the lending conditions on the day, which nobody can promise today.
- What will the asset be worth? If you plan to sell it, a balloon larger than the asset's value at the end leaves you short. Vehicles and equipment lose value at different rates, so be cautious.
- What does the contract say about the final payment? Check for any fees, conditions or restrictions on the asset linked to the balloon.
- Is the lower repayment solving a real cash-flow problem? Sometimes it is, particularly for a business that expects the asset to earn money straight away. Sometimes it is just making a bigger purchase look affordable.
A sensible middle path
Balloons are not good or bad in themselves. A smaller balloon gives a more modest repayment reduction and a smaller interest penalty. If you are curious, try different values in our repayment calculator and watch how the repayment and interest move in opposite directions.
If you are also weighing up how much to borrow in the first place, it may be worth speaking with a finance specialist who can look at your circumstances; you can start an enquiry with our finance partner when you are ready.
The bottom line
A balloon moves cost from today to later, and adds to the total. That can be sensible when it is a deliberate choice and you have a clear plan for the final payment. It is a poor idea when it is chosen only to make the monthly number look smaller.
This article is general information with illustrative figures only. It is not advice or an offer of credit.
