Balloon Payments Bubble – Bursts!

John Vaughan (Financial Advisor) @ Lucid Living

The number of people structuring their vehicle finance with balloon payments has more than halved in the past four years, according to Wesbank.
“The number of South African consumers who opt for balloon payments when financing their vehicle has fallen significantly over the (past) four years, down from 22% in July 2007 to 9,5% in June this year,” the company said in a release.

This would suggest that lenders and borrowers are being more careful in how they structure vehicle finance.

Why are balloon payments dangerous? Simply put, although a balloon payment makes your dream car affordable, you end up paying heavy interest because this payment is only paid at the end of the loan period. Yes, it can reduce your monthly instalments, but in the long term you end up paying much more than you anticipated and can probably afford.

Chris de Kock, head of sales and marketing at Wesbank, said that both the borrower and the lender were at greater risk for a longer time with a balloon payment. “We found customers were using the mechanism to get themselves into cars they couldn’t afford, and that’s not good practice.”

A balloon payment will take longer to reach break-even – the point at which the amount owing on a car is equal to what the vehicle can be traded for. A vehicle financed over 72 months, with no balloon payment, would break even at 44 months. With a 20% balloon payment, you would only look at breaking even at 58 months. A vehicle financed over 72 months with a 10% balloon payment will increase the consumer’s interest cost by 8% – quite heavy!

Mr de Kock said one of the key reasons for the drop-off in usage of balloon payments was the National Credit Act. “Before, the longest you could finance a car was over 54 months. (But the introduction of) a 72-month period is the equivalent of a 30% balloon payment,” he said.

The fact that the average repayment period was now 63 months suggested the “majority” of loans were being paid over 72 months, he said.

Econometrix senior economist Tony Twine said a drop in balloon payment schemes was good news. “Balloon payments have always worked against buyers who want to get out early.” Mr Twine suggests that the drop in balloon payments “is an indication of growing maturity (among SA consumers).”

Encouragingly, consumers are becoming more aware of the structure of their finance deals and are also showing better credit sense, purchasing within their means. In fact, South Africans are opting to buy more affordable cars, which is a more realistic way to survive in tough times.