What is a Balloon Payment or Balloon Loan?
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A balloon loan is a risky financial move that allows you to have low monthly payments in your financing agreement, but with one exceptionally large payment at the end of the term. This final payment, which can be at least twice as large as your monthly payment, is referred to as a balloon payment.
This structure is sometimes used in mortgages, but is more often used in car financing and leases. This can be tempting since you can lower the monthly payments that you owe for your car, but for most lessees it is a dangerous idea. Having a solid financial plan for the entire term of the lease is absolutely essential, but even that might be enough to make a balloon loan feasible.
The best laid plans of mice and men can be thrown off completely by a changing economy, injury, illness, natural disaster, or any other unforeseen change. That plan to save money on the low payments now so you can afford the balloon payment later won’t work if your income is lost or your expenses go up, and you will have to find a way to pay up or get out.
The Consumer Financial Protection Bureau advises you to take caution if you are considering agreeing to a balloon loan, and CoPilot echoes that sentiment. We will go over some potential solutions if you are worried about your looming balloon payment, and the risks still associated with each of them
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Refinancing
The first route to consider is attempting to refinance your loan. This does require you to be in good financial standing, so this is more of an early, preventative measure to reduce your risk if you’ve fallen into one of these loans and found it is not what you wanted.
This method will involve increasing your monthly loan payments, so it might be a tough pill to swallow, but if you have the funds to do so right now, it is likely a safer option. Interest rates always fluctuate so you should try to do this when you can get a rate as low as possible to refinance, but the only part of your rate that you have some semblance of control over is your credit rating.
So, if you want to get a new financing agreement, you need to keep making your current payments on time and in the full amount.
Trade In or Sell Your Car
If refinancing is not an option right now, whether you couldn’t afford the larger, more even payments, or you’re your credit rating is not where it needs to be to get a good refinance, or the interest rate has gone up, another option would be to sell your car or trade it in. If you can sell the car to a private buyer or a dealership, it should help you pay off most or hopefully all of your financing.
Once you have the balloon loan paid off from selling the car, you can buy another, less expensive car and get it financed with a more stable loan that doesn’t rely on you saving up for a massive payment at the end. But this solution does carry some caveats and risks.
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First, you have to hope that the car is worth as much as you owe on it. This depends on a wide variety of factors, such as the mileage and condition of the car, how many similar cars are listed for sale, and how interested people currently are in buying cars.
If your car has more value than the remainder of the loan you owe, that is called equity, and you will be able to pay off your loan when you sell your car. But if your car is damaged, or the market is saturated with the same model, or people aren’t buying cars, not only will it be more difficult to sell the car, but you might not be able to get the full amount you owe back.
This might still be a less costly option than having to make a massive payment that you can’t afford later, but you must weigh your choices. You should also consider the fact that you will need to find a new means of transportation.
That means that if you can’t afford to buy a car in cash you will have to secure an auto loan and find a car to buy as soon as possible, or you can expect to rely on rides from friends, buses, bikes, or rideshares for a while.
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Solutions for Leases with Balloon Payments
If your balloon loan is for a lease, you could try to secure a buyout loan. All lease agreements have a built-in buyout clause that lets you pay the remaining balance of the loan plus the residual value and any associated fees to take ownership of the car.
The residual value is the expected wholesale value of the car at the end of the lease term that you and the dealership agreed to at the start of the beginning. So if the balloon loan you have is for a car lease, you can secure a loan from a bank or lender to pay that buyout clause.
You can ask the dealership how much the buyout clause would cost at any point, and once you have that price, you can shop around with various creditors and secure a loan with a good interest rate and more steady monthly payments.
The downside to this option is that it locks you in to financing for longer than you already were with your lease, and might come at a higher monthly rate to avoid backloading the payments. But one advantage is that you do still have your car, if you make all your payments you will be the owner of the car, and if the payments aren’t great, this gives you more time to try the first two solutions.
If you are close to the end of your lease term and intend to lease another car once it is over, you might also have the option to roll the balloon payment into the next lease.
This does mean that you might have to lease from the same dealership as your previous lease, but it allows you to break up that balloon payment over the course of the new lease in much more manageable chunks.
This is great if you already planned on a new lease when yours ended, as long as you now know the benefits and drawbacks of a balloon loan for next time.
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