Balloon Payments May Pop Your Dreams

John Vaughan (Financial Advisor) @ Lucid Living

Ready to buy your fist car? Golf GTI or Mini Cooper S – what will be the right status symbol that defines you?
Its going to be the Golf GTI!
You have been quoted R220 000 for a new GTI with a balloon repayment of about 40% and you can afford the monthly instalment.
You don’t want any other car, but a GTI. How bad can a balloon repayment option be? Should you or shouldn’t you go ahead and buy the car?

You ask “how bad can a balloon repayment be?”. Bad, very bad. For clarity, a balloon payment or residual payment is only paid at the end of the loan period and you continue to pay interest on it.

Let’s do some maths.

The value of the car
The second you drive your GTI out of the dealership it falls in value. Based on historic depreciation values of GTI’s, after three years your car will have fallen by 33% in value. That means you would have lost R72 600 in value.

Let’s assume the dealer offered you a repayment period of 72 months (six years) in order to make the repayments even lower. It is safe to assume that after six years your car would have lost 50% of its value and would be worth R110 000.

The value of the balloon payment
A 40% balloon repayment means that you have a debt of R88 000 which you are not paying off. This means you are paying interest on R88 000 for six years. At an interest rate of 11,5% (I have assumed 2% above prime) you will pay R87 000 in interest on that R88 000 balloon payment over 72 months.

Not only have you now paid the equivalent of the residual payment in interest, but you now have to pay the R88 000 lump sum. Either you will have to sell the car or you will have to re-finance it for another few years. You will be paying this car off for longer than you want to be driving it.

The premise that you can afford the car is incorrect unless you believe that you will discover R88 000 sitting in your bank account in six years’ time.

Vehicle finance deals, structured with a balloon payment / residual payment, are becoming less attractive to consumers – as is evident from that latest statistics, reflecting a significant fall off (see related article: Balloon Payments Bubble – Bursts!).

Chris de Kock, head of sales and marketing at Wesbank advises, “as long as the consumer has a clear understanding of how long they intend to keep the vehicle, then the finance agreement can be structured intelligently to ensure the consumer can trade out of the vehicle at that point.”

According to de Kock “a well-structured balloon payment has to ensure that a vehicle is worth the same or more than the balloon payment amount at the end of the contract. It should not be a burden to the customer. However, about 65% of WesBank’s customers on balloon payment structures will ask to re-finance the balloon on termination.”

The temptation to have the car right now is very great. Who wouldn’t want to climb into that sexy car if they had half a chance?

The future
What I can say with conviction is that in six to 10 years’ time when you are in your thirties, starting a family and wanting to buy a home, you will regret this decision.

According to the banks, the single biggest reason people get turned down for a home loan is because of their car debt. Opting for a less expensive car could mean the difference between being turned down for a home loan or having the deposit to buy your first home.