At first glance, balloon payment auto loans seem like a good idea. After all, which car buyer wouldn’t want low monthly payments? But there is more to these loans than just low monthly payments. Learn why you should be wary of balloon payment auto loans by reading on.
What is a Balloon Payment Auto Loan?
A balloon payment auto loan is also known as partially amortized loans. A significant percentage of the loan amount will be amortized over the loan term while the remaining balance will be paid as a lump sum at the end of term. It is called a balloon payment for a reason—the car buyer is expected to make a balloon payment at the end of the repayment period to settle the loan in full.
Consider this example: with a $30,000 balloon payment auto loan, you can amortize $10,000 over 60 months (or five years). At the end of 60 months, you need to pay $20,000 to officially own the car.
What are Its Benefits?
The key benefit offered by a balloon payment auto loan is lower monthly payments. Balloon payment auto loans are structured to lower car payments by allowing you to amortize only a part of the financed amount. As a result, you are required to pay a comparatively small sum every month. With traditional auto loans, you amortize the entire amount so you pay a bigger amount on a monthly basis.
Moreover, this kind of loan usually doesn’t require a down payment. So if you need a car immediately and you don’t have enough money saved up for a deposit, getting this kind of loan could be a good idea.
What are Its Downsides?
Balloon payment auto loans may reduce the monthly payment, but these do not reduce the overall loan cost. The loan forgoes periodic payments for a substantial portion of the loan and instead demands a lump sum payment for the said portion. Unless you are absolutely sure you will have or can come up with the huge amount required at the end of the loan term, paying off this loan will prove challenging.
Another disadvantage of a balloon payment auto loan is that it makes being upside down inevitable. Know that the amortized payments mostly go to interest; the lump sum at the end of the loan is that which pays off the loan principal. Knowing how fast autos depreciate, you can expect to owe more than what your vehicle is worth.
Yet another disadvantage is the difficulty of refinancing. If you have negative equity, refinancing will no longer be an option for you. If you are fortunate to get approved for refinancing, your loan term will most likely be extended.
One notable danger of balloon payment auto loans is that these encourage consumers to buy cars they couldn’t truly afford. The loan is structured to make even expensive vehicles seem inexpensive, at least until before the lump sum payment is due.
A Reminder for Car Buyers
We at Denver Auto Approval Center would like to remind all Denverites like you to shop for an auto loan based on the overall cost rather than monthly payments. If you look at the big picture, instead of just focusing on monthly payments, you don’t only save more but also avoid getting in financial trouble.