How to pay up your loan?
A balloon or residual payment is a last lump sum repayment that in most cases would be larger than your normal periodic instalments. This would reduce your periodic instalments as you would have a larger last payment, but this would also increase the total amount of interest payable over the loan term.
What Is The Difference?
A residual payment is for various types of Lease Agreements and would be subject to GST, where a balloon payment would be on any other loan type, such as a Consumer Loan, Chattel Mortgage or Hire Purchase Agreement.
Residual payments will usually use set guidelines put in place by the Australian Taxation Office and may have less flexibility, whereas a balloon payment will be at the borrower’s discretion up to a maximum amount as per the lender’s guidelines.
What Are The Benefits?
Borrowers mostly like them for the purpose of reducing their repayments, but you can also do this with many lenders by opting for a 7 year loan term if the vehicle is used predominantly for personal use. Business use products with most lenders may not have a 7 year loan option though. No lender at the time of writing will allow a balloon payment on loan terms over 60 months.
Accountants may recommend a balloon payment as this will make a higher proportion of your outgoing cashflow, being your repayment, tax deductible on those loan products that allow the interest component of your repayment to be claimed as a tax deduction.
What Are The Pitfalls?
A residual or balloon payment comes with its own risks and downsides too. The amount of interest paid over the term of a loan would be higher than that with a loan of the same term without a balloon payment, but you must be comfortable with the higher repayments.
My biggest concern is that circumstances could change during the whole loan, which could be out of the borrower’s control. This could actually prevent the borrower from satisfying all their loan conditions, namely making their repayments on time which could give a negative borrowing history.
If this occurred and the balloon payment became due and payable, unless the borrower had the balloon amount as a lump sum saved, they may be left with no other option than to sell the vehicle to payout the balloon. This could be due to no-one wanting to refinance the balloon, or allow for an upgrade based on the poor previous car loan history.
If that same borrower opted for a 7 year loan term instead of the balloon, if they could not borrow more money at that time due to their past loan conduct, at least their car would be paid out after 7 years and they would own it with no large last payment like a balloon would leave.