A balloon payment, also called a residual, is a lump sum left owing at the end of a car loan or asset finance facility. Regular repayments cover only part of the amount borrowed, which makes them lower, and the balance falls due in one payment when the term ends.
On episode 105 of the podcast, Scott Knight of Motorlend and Dion covered the decisions that sit at the end of a facility as well as the start. The balloon is the main one.
How does a balloon payment work?
Take a vehicle financed over five years. Without a balloon, the repayments clear the whole amount by the last month. With a balloon, the repayments are calculated to leave an agreed amount outstanding. You pay less each month and owe that amount at the end.
ASIC's Moneysmart describes the trade plainly: the monthly payments will be smaller, but the lump sum is repaid with interest, so the total cost of the loan is generally higher (ASIC Moneysmart). Interest is charged on the balloon amount for the whole term, because it is never paid down along the way.
What changes with and without a balloon?
| No balloon | With a balloon | |
|---|---|---|
| Monthly repayment | Higher | Lower |
| Owing at the end | Nothing | The balloon amount |
| Total interest | Lower | Generally higher |
| Equity in the asset | Builds through the term | Builds more slowly |
| End of term | You own it outright | Pay, refinance, sell or trade |
| Next loan application | Higher commitment counted | Lower commitment, plus a debt due later |
Why do business owners use them?
Cash flow. A lower monthly commitment leaves more working capital in the business during the years the asset is earning. For a business that replaces vehicles or equipment on a regular cycle, a balloon can also line the debt up with the planned changeover: the asset is sold or traded, and the proceeds clear the balance.
A balloon also changes how the facility reads on a later application. A lender assessing you for property counts the monthly repayment, so a lower repayment uses less borrowing capacity. That is covered in how a car loan affects your borrowing capacity. It is a reason to understand the effect, not a reason to choose the largest balloon available.
How big should a balloon be?
No bigger than the asset is realistically worth at the end of the term. That is the test from the episode. Chosen well, a balloon matches the resale value at that point. Chosen for the monthly saving alone, it can leave a business owing more than the asset will fetch.
That makes an estimate of future resale value part of the structure, not an afterthought. It depends on:
- The asset. Some vehicles and machines hold value better than others.
- The use. High kilometres or heavy work reduce what it will sell for.
- The term. The longer the term, the lower the value at the end.
- The market. Electric and hybrid vehicles raise the same question in a newer resale market with less history.
Lenders also set their own limits on how large a balloon can be for a given asset and term.
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What happens when the balloon falls due?
- Pay it. From cash, and the asset is yours outright.
- Refinance it. A new facility over the balloon amount. This is a new application, assessed on your position at that time, on an asset that is now older.
- Sell or trade the asset. The proceeds go to the balloon. If the asset is worth less than the amount owing, you make up the difference.
The risk sits in the second and third. Refinancing is not automatic, and an older asset can narrow the lenders available. A sale only clears the debt if the value is there. Both are known years ahead, which is why the end of the term belongs in the plan at the start.
When does a balloon not suit?
- When the asset will be kept for a long time. You pay more interest to delay a cost you will meet anyway.
- When resale value is uncertain. The balloon is fixed. The value is not.
- When the monthly saving is the only reason. If the repayment only works with a large balloon, the asset may be outside the budget.
- When a large commitment is planned for the same year. A balloon falling due alongside a property settlement or a loan expiry concentrates risk.
How a balloon is treated for tax and in the business accounts is a question for your accountant. Wider lending for business owners is covered in self-employed lending.
Common questions
What is a balloon payment?
A balloon payment, also called a residual, is a lump sum owing at the end of a car loan or asset finance facility. Regular repayments cover only part of the amount borrowed, so they are lower, and the remaining balance is due in one payment when the term ends.
Is a balloon payment a good idea?
It depends on the asset and the plan. A balloon lowers the monthly repayment, which helps cash flow, but ASIC’s Moneysmart notes the total cost of the loan is generally higher. It suits best when the balloon is no more than the asset will realistically be worth at the end of the term.
What happens if I cannot pay the balloon at the end?
The usual options are to refinance the balloon amount or to sell or trade the asset and use the proceeds. Refinancing is a new application assessed at that time and is not assured. If the asset sells for less than the balloon, you need to cover the difference.
Does a balloon payment affect borrowing capacity?
It can. A balloon lowers the monthly repayment a lender counts as a commitment, which uses less borrowing capacity during the term. The balloon itself remains a debt that falls due later, and lenders may take that into account.
The takeaway
A balloon does not make an asset cheaper. It moves part of the cost to the end and charges interest for the delay. Used on purpose, with the amount matched to what the asset will be worth, it supports cash flow. Used to make a repayment fit, it stores up a problem.
If you are setting up finance for the business and planning for property as well, Book a Call. Fifteen minutes with the team will tell you whether the two are structured to work together.
This article is general information only. It does not take your individual circumstances into account and is not credit, tax, legal or financial product advice. All lending is subject to individual assessment and lender criteria. Speak with your own advisers before acting. The tax and accounting treatment of a balloon is a matter for your accountant.