Considering a balloon payment auto loan? This can be a very appealing option for some. If you are unfamiliar with the basics of a balloon loan, read on to find out more.
Definition of a Balloon Loan
In a traditional car loan, you pay the same amount over a set amount of months. Whether you are in the beginning, middle, or end of your loan term, the payment amount never changes. This is not the case with a balloon loan. In a balloon auto loan, you start off with very small payments. Over time the payments may either increase in size, or they may stay small for most of the loan and then you'd have one big payment at the end to pay off the loan. In the latter example, usually you would be paying off the principal on the loan in the final payment.
Advantages of a Balloon Loan
There are many reasons that people find balloon loans so appealing. Most obviously, this kind of auto loan makes the payments extremely affordable, at least for the beginning of the loan. If the buyer has strong reason to believe that their financial situation will markedly improve within the next few years, going with a balloon loan might make sense. In addition, because the early payments are so low, it's far less likely that the car will be repossessed.
Risks of a Balloon Loan
Where people run into trouble with a balloon loan is when they don't have a plan as to how to pay off the final payments on the loan. They may say, "Oh, I know my situation will be better in 3-5 years", but they don't have plan as to how to get to that point. Or, they are not disciplined enough to set aside the money that will be required to make the final payment on the loan. Selling a car with a balloon loan can be extremely difficult. In most cases you are only paying the interest on the loan for the early part. Meanwhile, the car is continuing to depreciate in value. By the time you make the final payment, you could very likely owe more than the car is worth.
Balloon payments are certainly not for everyone. However, if you are financially disciplined and plan to hang onto the car for several years, it could be a good option. You'll be able to enjoy a nicer car than what you could otherwise afford, and know that your payments up front will be well within your budget.