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A balloon payment is a kind of loan that comes with lower monthly payments followed by one big “balloon payment” at the end of the loan term. If you’re trying to buy a new car, you might come across balloon payment as an auto financing option.
Those lower payments might look attractive, but don’t jump at your first chance to take on a balloon loan, as they come with significant dangers that might outweigh their benefits. If you can’t make the last payment and pop the balloon at the end of your loan, the consequences could be serious.
If you choose to take out a balloon loan on your car, you’ll need to save money from the start of your loan term to prepare for your last big payment. A great way to save money on car expenses is by finding a lower rate on your car insurance with Jerry. As a licensed insurance broker, Jerry will find competitive quotes from top insurance companies in just 45 seconds!
Not sure whether or not to take on a balloon payment on your car? Here’s what you need to know if you’re considering a balloon loan for your next car purchase.
How a balloon car loan works
A balloon loan offers lower monthly payments in exchange for one big payment at the end of the loan term. This auto-financing option is an alternative to a traditional car loan.
Balloon loans vs. traditional auto loans
If you take out a traditional auto loan on your car purchase, you’ll make regular monthly payments to pay off both the principal balance and the interest on the loan. Exactly how much you pay each month depends on the loan amount, interest rate, and loan term, but you’ll pay the same amount every month until the entire principal and interest are paid off.
The big draw of a balloon loan is the low monthly payment you’ll be responsible for each month. But those lower month-to-month payments come with two big trade-offs. First, you may have a higher interest rate than with a traditional auto loan. Second, your final payment will be a big lump sum—that’s the “balloon” at the end of your loan.
The exact amount of the balloon payment varies, but it’s typically based on the car manufacturer’s suggested retail price (MSRP) and could be up to half the car’s value. Whatever calculation your lender uses to set the balloon payment, you’re probably looking at a lump sum of thousands of dollars.
Key Takeaway If you take out a balloon loan on your car, you’ll have lower monthly payments, but you’ll be responsible for a final lump sum payment at the end of the loan term, which could be as much as half the car’s value.
MORE: How to buy a new car
How to deal with the final balloon payment
If you do choose to take out a balloon loan, you’ll have a few different options when you reach that final payment. The simplest option, of course, is to make the full payment. Just like any other loan, you’ll be debt-free and get full ownership of the vehicle.
If you don’t have the full amount, however, consider one of the following options:
- Trade in the car. Check with your lender to see if this option works for you. Depending on their policies, you could still be on the hook for all or some of the loan amount.
- Return the car. If the value of the car covers the remainder of the loan, this might be a good option—but be cautious! You’ll still owe money if the balloon payment was larger than your car’s current value.
- Refinance your auto loan. You’ll retain ownership of the vehicle and buy yourself more time to pay off your loan.
No matter which option you choose, make sure to communicate clearly with your lender beforehand so that you understand all your options and you’re aware of any potential fees. If you trade in or return your vehicle, there could be fees associated with excess mileage, wear-and-tear, or preparing the vehicle for sale.
Key Takeaway Your simplest option is to pay your final balloon payment in full, but if you don’t have the money, you can trade in or return your vehicle—or you could refinance your loan.
MORE: How to refinance a car
Should you get a balloon loan?
Balloon loans, like all auto financing options, come with advantages and disadvantages. If you want lower monthly payments and you know you’ll be able to handle the final lump sum, it could be a good idea. But if you know you won’t be able to afford the balloon payment, a balloon loan could come with some serious risks.
Benefits of a balloon loan
Taking out a balloon loan on your car gives you the ability to own the car while paying lower monthly bills that are closer to a lease payment. It also buys you time to collect the money you’ll need to pay off the full debt.
Dangers of a balloon loan
The biggest danger with a balloon loan is, of course, not being able to cover that last payment. If you can’t pay that lump sum, it could hurt your credit score. If your credit got worse since you took out the loan, you may not qualify for refinancing—and even if you do, refinancing means taking on new debt.
A major risk with a balloon loan is ending up with an upside-down car loan—that is, a loan that’s bigger than the value of your car. If your car’s value decreases over the course of the loan so that it’s worth less than the final payment, you’ll be upside down, making it difficult for you to sell, trade in, or refinance your car.
Key Takeaway A balloon loan comes with attractive monthly payments—but don’t overlook the serious financial and credit risks associated with the final payment.
Plan ahead with a balloon loan
If you decide that a balloon loan is right for you, you’ll need to start saving for that final payment the minute the loan term starts. If you are prepared to pay the final lump sum, you can reap the benefits of a balloon loan without taking on unnecessary debt or damaging your credit.
Saving a little money every month will help you prepare for the final payment. Staying on top of car maintenance is one good way to save money by preventing unexpected expenses associated with your car.
Save up for your balloon payment with affordable car insurance
Car insurance is one of the biggest expenses associated with car ownership, so finding a lower rate can lead to major savings that will set you up for success when that balloon payment rolls around. To get that low rate, just download the Jerry app and answer a few questions—Jerry will do the rest!
Once Jerry’s found the low rate you need, they’ll handle all the paperwork to switch you over, and even cancel your old policy. Jerry users save an average of $879 a year on car insurance!
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