Having a residual value/Balloon payment will affect the amount of your regular monthly repayments, as well as how much you owe at the end of the loan period. These are also known as RV, Residual Payment, or Balloon.
How Balloon Payments Work
At the end of a loan when all repayments have been made, the lump sum still owed to the lender is called a residual value, or Balloon Payment. As a borrower, this allows you to repay part of the initial loan over the term, which will reduce the monthly repayments you pay. but means you will owe the lender a lump sum at the end of your loan term. This value may be represented as an absolute dollar amount, or a percentage of the borrowed amount.
For example: A new car buyer borrows $60,000 over 5 years and elects to have a $18,000 (30%) Residual Value/Balloon Payment on their loan. Monthly repayments will be lower than if they chose not to have a residual/balloon payment, but will owe the financier a lump sum of $18,000 at the conclusion of the five year loan.
With the exception of leases, having a Residual/Balloon Payment on a car loan is optional.
Benefits of Balloon Payments
Increased loan size: With lower repayments, the balloon payment option may potentially increase the loan size to help you afford a car or item that was previously just out of reach.
Cash flow management: Helps with ongoing cash flow management, particularly with businesses that need finance to help increase their profit margins in the long term.
More time to sell: If you’re upgrading to a newer car, you can wait for the best price before selling your current vehicle, knowing that when you do you will have access to the money to cover the balloon amount.
Upgrading: Some people use the balloon amount to keep their repayments down on a vehicle they plan on trading in at the end of the term.
Tax Deductions: Because you are paying less off the principal of your loan with each repayment you do end up paying more interest, which may be advantageous if your vehicle is for business use. For a business vehicle, the principal may not be tax deductible whilst the interest may well be tax deductible. This may allow your business to claim a larger tax deduction (talk to your accountant about if this could work for your business). Depending on your business situation, the right loan, can potentially be used to reduce tax, payroll tax and Work Cover premiums, whilst benefiting employees.
Balloon Payments and Leases
Leases usually come with a compulsory balloon payment. A lease means that the lender purchases the equipment and rents it back to the customer for a fixed monthly charge. The "balloon repayment" requires that you have a certain residual amount owing on your lease at the end of your lease's term. The ongoing repayments on a lease are generally fully tax deductible.
An experienced finance broker can use their skill and experience to tailor which type of car loan would best support your business, commercial and/or individual needs. A broker will help you to select the loan option with the best tax benefits, saving you money.