Balloon/Residual Value Payments
There are an overwhelming lot of options involved with the purchasing of a vehicle, and once you decide what car you want, the next decision is to determine the correct financing for you needs. One of the single-most important considerations when purchasing a car is the resale value; this is massively significant when it comes to calculating the cost of ownership. ‘Residual Value’ or ‘Balloon Payment’ loans certainly allow you better ‘short term’ affordability enabling you to drive a more expensive car that you otherwise would ,but can be very dangerous option in the long run if not understood properly.
A balloon/Residual payment is the lump sum amount that you will still owe, after completing the number of agreed upon payments. Retailers will offer these kinds of deals, to make vehicles more affordable
Short term Affordability:
Having a Residual Value/Balloon Payment affects the amount of your regular monthly repayments and allows you to pay a much lower instalment during the first few years. Instead of spreading the full vehicle price over a normal finance period like four or five years, you defer a percentage, say 30% of that lump sum to the end of your finance period.
Driving new cars regularly:
Balloon/Residual Payment car loans allow for a car to be sold at the end of the loan term and using the resulting cash to pay off the loan. This way you can re-enter such a deal and drive a new car again. Even though you would never own any equity in the vehicle, you experience the excitement of driving a new car every ¾ years with the latest safety features and always have a warranty.
If you are very certain that you would be in a better financial position in the future, a balloon/Residual payment might be an option for you. Having lower instalments during the loan term allows you to accumulate the cash due to pay off the lump sum at the end.
Residual loans are not for everyone and there are quite a few concerns you should be aware of when taking out a balloon/Residual payment car loan.
Expensive in the long run:
Car buyers are attracted to this way of financing because, it makes the purchase more affordable in the short run, thinking they will be better off financially when the loan term expires to settle the lump sum. The fact is that most people will not be better off financially in four to five years, as much as they hope or think they will be. A lot of people end up re-financing the outstanding ‘residual” lump sum making it a much more expensive way of financing a car.
No Equity in vehicle (constant payments)
Some people opt to sell a vehicle at the end of the loan term when faced with the ‘balloon” payment instead of refinancing the car, then buy a new car and re-enter a ‘residual” loan agreement. This way you never really own any equity in a car and will always have a vehicle instalment.
Interest vs Value
Having a balloon payment means you have an additional debt, the lump sum, which you are NOT paying off, but you ARE paying interest on it over the full loan term. At the end of the loan term, you are only paying the interest on the loan and you will likely owe more on the vehicle that is worth if the interest rate is unfavorable such an instance, you could face great difficulty in selling for the amount you owe or refinancing the loan.
In most cases, a balloon is not the right financing option and simply allows you to incur more debt that you can afford delaying the costs and, in the end, paying a lot more interest/fees for this privilege.
The biggest factor to consider is the depreciative value of a vehicle asset, typically in an entry level vehicle the following will apply:
1st year depreciation 20-25% (this means as soon as it leaves the showroom floor)
2nd and 3rd year depreciation 15%
4th year onwards 10%
So, lets put this into plain terms, let’s use a vehicle value of R180 000:
1ST year = R180 000 minus 20% = R144 000
2ND year = R144 000 minus 15% = R122 400
3RD year = R122 400 minus 15% = R104 040
4TH year = R104040 minus 10% = R93 636
Loan from the bank R180 000 over 48 months with a 40% R/V = R108 000 R/V after 4 years.
This means on an entry level vehicle you will still be short of R14 364 if the car is in mint condition. The more expensive the vehicle the more it depreciates as well.
No more needs to be said!
Terminating the deal /Vehicle
The ability to get out of a balloon payment/residual value is more difficult than settling a normal vehicle loan. You might be responsible for more early termination charges stipulated on the contract. Make sure you understand the penalties applicable, if any.