Using the balloon payment option to buy a car you can't afford might look tempting, but it carries much risk that can hurt your finances in the long run.
While many South Africans are turning to balloon payments when financing a new car to reduce their monthly repayments, it’s wise to consider the long-term implications before putting pen to paper.
Ernest North, co-founder of Naked, said the increase in the balloon payment option is due to rising costs of living, including the higher costs of car purchases and ownership. Unfortunately, many consumers go for the balloon option without understanding that they could get caught in a debt trap four or five years down the line.
What is a balloon payment?
Unlike normal vehicle financing, a balloon payment is a type of car loan where you pay lower monthly instalments for a period, covering a percentage of the loan amount, and then at the end of that term, you owe a large lump sum. This arrangement makes buying a car more accessible by reducing the immediate financial burden.
According to WesBank, about 27% of the finance deals approved by the bank last month were on balloon payment, a slight decrease from last year's 34%.
“The average balloon size chosen by customers was 33% last month. This is lower than the 37% average seen in July 2024. The drop in the balloon rate can be attributed to a shift towards more affordable vehicles that still meet customers’ specification or features requirements,” said Lebo Gaoaketse, the bank's head of marketing and communication.
Gaoaketse said about 94% of balloon finance deals they dealt with are structured as contract extensions, where the new instalment is aligned with the existing one through an addendum. The remaining 6% are either refinanced, traded in or fully settled.
“Lowering your monthly repayments can help you to stretch your salary a bit further and potentially affords a better car, but the lump sum at the end of the loan term is the sting in the tail. While a balloon payment can be a useful financial planning tool, all too many people find that they struggle to afford the final repayment,” explained North.
Financial institutions usually allow between 20% and 35% of the vehicle’s value as a balloon payment, with 40% being the maximum.
When the time for the last payment comes, the customer has the option of paying off the balloon payment outright to own the car, though some opt to refinance the outstanding amount.
“This means you’ll enter a new loan agreement and face another few years of making monthly payments and interest charges. You will need to qualify for financing to take this option. The other option is to extend the loan term to allow you to stretch out your repayment period further, though this could mean paying even more interest costs. Again, this is only possible if you’re creditworthy,” said North.
The last option is to sell or trade in your car, leaving you without an asset after forking out cash for months. But remember, you’ll still need to settle the balloon payment.
Risks of balloon payments
- You face significant financial risk because you’ll either need to have cash to pay the balloon payment at the end or you will need to finance it.
- The bigger the balloon payment, the higher the interest you pay over the full term of the loan.
- After depreciation, your car might not be worth as much as the balloon payment at the end of the loan.
- You may never own a car outright if you get caught in a loop of refinancing via a balloon payment plan.
- If you want to exit the loan early, you need to be prepared for early settlement penalties and the outstanding balloon payment.
- Even worse, if your car is stolen or written off in an accident, you will be forced into an early settlement and will need to pay a massive shortfall.
- If you can’t afford the final payment, you could face consequences such as repossession of the car.
North said despite the costs and risks, there are some instances where balloon payments can be a helpful tool in your financial planning. He said the balloon option only works for those who are likely to change cars and are confident that they can afford the final payment, or those who are paying the car through a business and can claim tax deductions on depreciation, interest, fuel and maintenance.
“If you’re still considering a balloon payment, a Guaranteed Future Value (GFV) finance option could be a safer alternative. GFV agreements add a layer of financial security by guaranteeing the value of your car at the end of the finance term, regardless of how much it has depreciated. This guaranteed amount functions as your balloon payment (also known as the optional final payment) and is agreed upon upfront,” said North.
North warned against using balloon payments to buy a car you can’t actually afford in the long term.
“Rather put down a larger deposit or choose a more affordable car. Remember, a more expensive car will also have higher maintenance and insurance costs. While it can make sense in some circumstances, the downside of a balloon payment is very seldom worth the benefit.”
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