A balloon payment car loan works differently than standard auto loans. Rather than making steady, equal payments throughout the loan’s term, you’ll pay lower amounts each month up until the very last payment, which is the balloon payment.
While a balloon payment car loan can help keep your car payments lower for the time being, there’s always the risk that you won’t be ready when the big payment arrives. Read on to learn more about balloon auto loan pros and cons and how they differ from traditional loans and car leases.
Key Points
• A balloon auto loan features lower monthly payments, with a significant final payment to settle the remaining balance.
• Monthly payments are reduced compared to traditional loans, but a large payment is necessary at the end.
• Managing the final balloon payment can be done through various methods: paying it, selling, returning, refinancing, or trading in the car.
• Pros include lower payments and cash flow benefits; cons are the risk of the large final payment and potentially higher interest rates.
• Plan ahead by saving or exploring refinancing options to manage the balloon payment effectively and avoid financial difficulties.
What Is a Car Loan With a Balloon Payment?
A balloon auto loan is a final scheduled payment on your car loan that’s substantially greater than the prior monthly payments.
With a balloon auto loan, payments are smaller over its term — until the last payment, when the remaining balance is paid off in a large lump sum. This is different from how car loans work usually, where borrowers make a series of equal payments spread out over the loan’s term (for example, 36, 48, or 60 months).
When looking at who offers balloon auto loans, you may find that these loans are largely limited to dealerships. There will likely be fewer options to compare as opposed to if you were looking for a traditional car loan or to lease a vehicle.
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How Balloon Auto Loans Work
Just like with traditional loans, the lender will offer an interest rate and certain terms and conditions for a balloon auto loan. What’s different about an auto balloon loan is that all but one payment will be lower: the final payment, or the balloon payment. This last payment will be significantly larger than the others, perhaps as much as half of the vehicle’s value.
The lender may, for example, offer a 48-month term with half of the amount due as the 48th or 49th payment. The other half of the amount owed would be broken down into 47 or 48 regular payments, which would be lower than what you’d get with a traditional car loan.
Balloon Auto Loans vs Traditional Auto Loans
As the definitions provided show, a car loan with a balloon payment is significantly different in structure than a traditional auto loan. While the monthly payments in a balloon payment auto loan are not intended to pay back the whole loan amount, traditional auto loan payments are designed to do exactly that.
To see exactly how balloon vs. traditional auto loans stack up, here’s a comparison. For the example, assume the following:
• The loan amount is $40,000.
• The loan’s term is 48 months.
• The interest rate is 6.00%. (Note that a lender may offer different interest rates for auto balloon loans and traditional auto loans. In fact, loans with a balloon payment tend to be a higher risk for lenders, who therefore may charge a higher interest rate. But, for the sake of comparison, this example assumes the rate is the same.)
Traditional Auto Loans
For a traditional auto loan, the lender calculates a monthly payment based on the loan amount, interest rate, and term.
In our example, the monthly payment would be $939. At the end of the loan, the balance would be paid in full.
Balloon Auto Loans
With a balloon auto loan, the lender calculates a monthly payment on a portion of the loan amount (we’ll use 50%), interest rate, and term.
In our example, the monthly payment would be $469.50. At the end of the loan, however, there would be a $20,000 balance remaining that could be covered in cash, by selling the vehicle, or by refinancing your auto loan.
Traditional Car Loan vs Balloon Auto Loan (Based on Above Example)
| Traditional car loan | Balloon auto loan | |
|---|---|---|
| How monthly payments are calculated |
• Based on the loan amount, interest rate, and term |
• Based on a portion of the loan amount, interest rate, and term |
| Amount of monthly payments |
• $939 |
• $469.50 |
| Balance remaining at the end of the loan |
• $0 (loan will be paid off in full) |
• $20,000 |
Auto Balloon Loan vs Leasing
Taking out a loan that comes with an ending balloon payment is different from negotiating a car lease. With the first, you’re buying the vehicle and seeking the financing to do so. With the second, you’re essentially renting the vehicle, often with an option to buy it at the end of the lease.
Plus, with a lease you’re agreeing to limiting parameters — most notably, that you’ll stay within certain mileage limits. This isn’t the case with an auto loan with a balloon payment.
That being said, an auto balloon loan and leasing can be similar. With a car balloon loan and a short-term car lease, you can refinance or pay off the remaining balance in cash. If paid off in cash, then the vehicle is yours, free and clear. If you opt to refinance, then you’ll make monthly payments based on that loan’s interest rate and terms.
Balloon Auto Loans Pros and Cons
Wondering what the upsides — and downsides — of balloon auto loans are? Here’s a rundown of balloon auto loan pros and cons:
Balloon Auto Loan Pros
Here are the potential positives of a balloon payment car loan:
• Up until the last payment, the amount owed is lower than with a comparable traditional loan.
• Depending on how the lender structures the loan, you may be able to sell the vehicle and use that money to make the balloon payment.
• You’ll have more cash in hand (until the final payment is due), which can help with cash flow.
• You could take the difference between the traditional payment ($939 in our example) and the balloon one ($469.50 in our example) and save or invest those funds.
• Because payments are lower, it’s more likely that you’ll be able to meet the monthly obligation.
Balloon Auto Loan Cons
On the other hand, here are the possible pitfalls of a car loan with balloon payment:
• It may be challenging to make the final payment.
• Interest rates may be higher.
• Not making the balloon payment can hurt your credit scores.
• The smaller payments you’re making mostly go to interest, which can put you in an upside-down situation (where the vehicle is worth less than what’s owed on it) if you try to sell or refinance the car when the balloon payment is owed.
• Because the pre-balloon payments are much smaller than they would be with a traditional loan, it can be tempting to spend more than you can afford on the vehicle.
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Options for Dealing With a Balloon Payment
Here are some possible options for dealing with a balloon payment:
Paying the Car Off
One option for dealing with a balloon payment is simply paying it off when due. Making the large payment when due at the end of your balloon auto loan term would effectively pay off the loan and give you full ownership of the car.
Selling the Car
Another option for dealing with a balloon payment is selling your car to help you cover the outstanding balance of the loan. As mentioned earlier, you may be able to sell the vehicle and use that money to make the balloon payment.
Returning the Car
Some lenders may give you the right to return the vehicle as an alternative to making the large balloon payment. Lenders, however, may impose certain fees if you return the vehicle as an alternative to making the balloon payment.
Refinancing
Certain lenders may allow you to refinance a balloon auto loan as an alternative to making the large balloon payment. Refinancing allows you to replace the large final payment with manageable monthly payments by securing a new loan. To refinance, you’ll need to meet the lender’s credit requirements and provide necessary documentation like income proof and vehicle details.
Trading It In
You may consider trading in your car as an option for dealing with a balloon payment. Trading in your car may be challenging if your balloon auto loan is underwater. But if the value of your car is greater than the balloon payoff amount, trading in the vehicle at a car dealership can help you meet your balloon payment obligations.
Planning Ahead for Your Balloon Payment
Planning ahead for your balloon payment can help you determine a course of action that’s right for you. You can budget and set money aside if you plan on making the lump sum balloon payment. Or, you may choose to refinance your balloon auto loan. If so, it’s best to shop around for lenders and apply for the refinance well before the balloon payment is due.
Unless required by law, there’s no guarantee a lender will approve your balloon refinancing request. Planning ahead can help you prepare for your looming balloon payment or help you determine an alternative course of action that’s right for you.
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Is a Balloon Payment Car Loan Right For You?
Times when taking out a balloon payment car loan can make sense include the following situations:
• You’re expecting additional income to be available when the balloon payment is due.
• Investments you own will mature before the balloon payment is owed.
• You have the money to make the higher payments, but you appreciate how the lender is carrying the deficit for you during the loan’s term.
• You don’t have much money for a down payment, but you can meet the monthly car payments (and will be able to manage the balloon payment).
On the other hand, if you have any doubts about your ability to hand over that hefty last payment at the end of the loan’s term, a balloon payment auto loan might not be the best idea.
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Requirements for Balloon Payment Auto Loans
Although each lender will have its own requirements, in general, the two main requirements for a balloon auto loan are similar to those of a traditional car loan. Specifically, you will need to:
• Have steady employment and an income that demonstrates to the lender that you can meet the car payments.
• Have a credit score that meets or exceeds the individual lender’s standards.
Other Ways to Lower Your Car Payment
The lower monthly amount of a balloon payment car loan is an attractive feature to many people who want to buy a vehicle. If you’re seeking to lower the payment on your current vehicle or are exploring how to pay off a car loan with balloon payment, refinancing also can be an option.
You may decide to refinance with the same lender again, or you may compare loan programs among various lenders.
In either case, take into account the cost to refinance.
Before refinancing, it’s also important to take into consideration the pros and cons of refinancing your car. While you may end up with lower interest rate or lower monthly payments, thus freeing up some extra cash, you could also face fees and prepayment penalties.
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The Takeaway
When buying a vehicle, a balloon loan is structured differently from a traditional vehicle loan. Payments throughout the term are lower because they’re based on only a portion of the loan amount with the remainder of what’s owed due and payable on the loan’s last payment. There are pros and cons to balloon payment car loans, and it makes sense to carefully weigh them before making the decision that’s right for you, as well as consider other options for affording a car.
If you’re seeking auto loan refinancing, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your car in minutes.
FAQ
Is a balloon car loan a good idea?
A balloon car loan can be a good idea if you want lower monthly payments and plan to pay off the loan or trade in the car before the balloon payment is due. However, it carries risks, including a large final payment and potential difficulty refinancing or selling the vehicle.
Can you pay off a balloon car loan early?
Yes, you can typically pay off a balloon car loan early, but it’s important to check your loan agreement for prepayment penalties. Paying early can save on interest and reduce financial stress from the large final payment, making it a smart option if your finances allow.
Can you pay off a balloon payment in installments?
Paying off a balloon payment in installments depends on your lender’s terms. Some lenders may allow restructuring the payment into smaller installments, but this often requires refinancing. Discuss options with your lender in advance to avoid default or financial strain when the large final payment becomes due.
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