Written byA balloon payment is a lump sum, agreed upfront, that is paid at the end of a loan term and lowers the regular repayments by deferring part of the principal.
Also known as: balloon, final lump sum, residual payment
Key points
- It is usually set as a percentage of the amount financed, commonly between 20% and 40% on car and equipment loans.
- Lower repayments now come at a cost: interest accrues on the deferred amount, so total interest over the loan is higher.
- At the end of the term you can pay the balloon, refinance it, or sell or trade in the asset to clear it.
- On a lease the equivalent figure is the residual value, an estimate of the asset's worth rather than a contracted repayment.
How a balloon payment works
A standard loan spreads the whole principal across the repayments, so the balance reaches zero with the last instalment. A balloon loan only has to bring the balance down to the balloon amount by the end of the term, not to zero, so each repayment is lower. The held-back amount is then paid in one hit when the term ends.
The balloon is fixed in the contract as a dollar figure or a percentage, and interest is charged on the full outstanding balance, including the balloon, for the whole term. That is why the saving on each repayment is smaller than the balloon alone would suggest. Balloons are common on chattel mortgages, car loans and hire purchase agreements.
What happens at the end of the term
You have three main choices. Pay the balloon in full from savings or the business account. Refinance it into a new loan, which means a fresh credit assessment and a new set of repayments. Or sell or trade in the asset and use the sale proceeds to settle the balloon, keeping any difference.
The risk sits in that last option. If the asset is worth less than the balloon when the term ends, you cover the gap. Ask your lender for a payout figure a few months before the balloon is due so you can plan the early settlement or refinancing in time.
When a balloon makes sense
A balloon suits borrowers who value lower monthly repayments and have a clear plan for the lump sum: a business matching repayments to cashflow, or a buyer who expects to upgrade the vehicle at the end of the term and sell it to cover the balloon.
It is a poor fit when the lowest total cost matters most, when the asset loses value quickly, or when there is no realistic way to pay or refinance the lump sum. Run the numbers both ways before you sign.
Example
A tradie finances a $50,000 ute over five years. With no balloon, the repayments have to clear the full $50,000. With a 30% balloon, they only have to bring the balance down to $15,000 by the end of year five, so each repayment is lower. Interest is still charged on the whole balance throughout, so the tradie pays more interest in total and still owes $15,000 when the term ends.
Not to be confused with
- Residual value
- a residual value is the financier's estimate of what a leased asset will be worth at the end of the term; a balloon is a contracted repayment on a loan
Frequently asked questions
Is a balloon payment a good idea?
It can be, if you need lower repayments and have a plan to pay, refinance or sell the asset to cover the lump sum. It is less suitable if you want the lowest total interest cost or the asset is likely to be worth less than the balloon at the end. Compare the total cost with and without a balloon before deciding.
How does a balloon payment work?
Part of the loan principal is set aside as a lump sum due at the end of the term. Your regular repayments only have to reduce the balance to that amount rather than to zero, so they are lower, while interest is charged on the full balance. When the term ends you pay the balloon, refinance it or sell the asset to clear it.
Why would someone do a balloon payment?
Usually to free up cashflow. Lower repayments can help a business match loan costs to income, or let a buyer afford a vehicle they plan to upgrade in a few years. Some borrowers also use a balloon to keep repayments in line with how quickly the asset is expected to lose value.
What is a 5 year balloon payment?
It is a loan with a five-year term that ends with a lump sum rather than a final regular repayment. For example, a five-year car loan with a 30% balloon has 60 monthly repayments that reduce the balance to 30% of the amount financed rather than to zero, and that remaining 30% is paid, refinanced or covered by selling the car at the end.
What happens if I can't pay the balloon payment?
Talk to your lender before the due date. The usual options are refinancing the balloon into a new loan, selling or trading in the asset to cover it, or agreeing a short extension. If nothing is arranged the balloon falls into arrears, which can lead to default and repossession.
Related terms
Residual value
Residual value is the amount a leased car or asset is expected to be worth when the lease ends, set at the start and used to calculate the rentals.
Read definitionChattel mortgage
A chattel mortgage is a business loan for a vehicle or equipment: you own the asset from settlement and the lender holds a security interest until it is repaid.
Read definitionHire purchase
Hire purchase is a finance agreement where a financier buys an asset and hires it to you for fixed instalments, with ownership passing to you at the final payment.
Read definitionAmortisation
Amortisation is the process of spreading a cost over time: repaying a loan in scheduled instalments of interest and principal, or expensing an intangible asset over its useful life.
Read definitionPrincipal
Principal is the amount of money you originally borrowed or, on a running loan, the part of that sum you still owe, excluding interest, fees and charges.
Read definitionEarly settlement
Early settlement is paying a loan or lease out in full before the end of its term using the lender's payout figure, or bringing a property settlement date forward.
Read definitionGo deeper
Sources
This article is general information only and is not financial advice.