Not everyone has the cash flow to manage the full monthly repayments on a large car loan or lease. And even if they do, it’s not always necessarily the best use of their funds to do so.
And that’s where balloon payments and residual values come in.
In a nutshell, balloon payments and residual values both represent an amount of money that has been offset from the purchase price of the vehicle. It is separated from the normal cycle of monthly repayments, and is paid in a lump sum at the end of the term of the car finance.
The size of a balloon payment or residual value directly affects the size of your monthly repayments. The larger the balloon or residual value, the smaller the monthly payment, and vice versa. It can be expressed as a dollar amount, or as a percentage of the loan.
Residual values apply to leases. A residual value is a forecasted depreciated value of your car at the end of your lease term. For example, if you will take a loan for a car over 3 years, the residual value will be the value it still has after those 3 years have passed.
Before a loan or lease is started, the financier will normally determine the residual value of a car, based on various models and forecasting tools that they use.
The residual value reduces the monthly instalments (also known as rentals). Unlike Balloons, a residual value isn’t flexible and is determined by guidelines created by the ATO. In order to avoid liability for Fringe Benefits Tax (FBT) a novated lease must have a Residual Value.
A balloon payment is the term used for finance structures such as a Chattel Mortgage, Commercial Hire Purchase or consumer loan. Unlike Residual values, the size or amount of a balloon payment is flexible, and can be maximised in order to minimise the monthly repayments. They’re not mandatory, and the amount is negotiated with the financier at the time of writing the finance.
The Australian Tax Office sets the minimum amount of the balloon payment.
The minimum can range between approximately 28% and 65%, depending on the number of years of the lease term.
HOW IS BALLOON OR RESIDUAL VALUE PAID OUT?
At the end of the loan or lease term, when the balloon or residual value amount becomes due, it must be paid out. This can be done in a number of ways, including:
- Paying it out in cash and keeping the car
- Rolling over the balloon or residual value amount into a new lease or loan
- Selling the car and using the proceeds to pay out the lease or loan
WHAT’S THE ADVANTAGES OF A BALLOON OR RESIDUAL VALUE?
The main benefit of both a balloon and residual value is that they reduce your monthly repayments. This can mean greater affordability, and therefore improve cash flow. For business users, having a balloon in place can be a tax effective measure, as it increases the amount of interest payable over the term, and reduces the amount of undetectable principle that is paid.
Other benefits include:
- Short term affordability: having a balloon or residual value allows you to pay much less on your monthly instalments during the first few years
- Driving new cars: because you can sell the car at the end of the lease or loan, you can pay off the loan, commence new finance and buy a new car. This gets you the latest safety upgrades and keeps you under warranty
- Manage cash flow: if you don’t have the cash flow right now, lower instalments initially allow you to have your cash where you need it most, and they give you time to save
- Access to higher end cars: higher maximum loan amounts are possible, giving you greater access to prestige brands
- No need for upfront equity
Remember, it’s important that you make sure any finance deal works for you, especially when you’re committing to large lump sum payments in the future. Make sure you talk to the AutoTender team today; we’re the experts in helping you get your finance right, and we’ll always make sure you get the best deal.