WesBank has warned South Africans who are looking to buy a new car that they should not use a balloon payment to finance a vehicle they cannot afford.
This comes after a strong increase in new car sales in the country as lockdown restrictions have eased.
“Being responsible with your money and keeping within your budget are key to managing a balloon payment option, if you are considering it,” said Kutlwano Mogatusi, WesBank Communication Specialist.
“Balloon payment deals require discipline. If a buyer is not financially savvy enough to manage cash flow and continue to save during the finance term, then a balloon deal is probably not the best option for that person.”
How a balloon payment works
WesBank stated that a balloon payment allows a car buyer who is taking out a finance plan to “take an amount owing on the purchase price of a car and set it aside”.
This means the monthly finance repayments are calculated using a lower initial value – making the car payments more “affordable”.
“You’re essentially paying off a loan for most of the car, but not all of it. The amount set aside at the onset remains the buyer’s responsibility and will need to be settled in the long run,” said WesBank.
Key to deciding whether you should use a balloon payment extends beyond financial discipline, however.
Car buyers must also ensure they understand the “breakeven point” on their finance plan, said WesBank.
“The breakeven point occurs when the financed car’s trade-in value matches the amount still owed to the bank. When calculating the breakeven point, it’s important to include the amount outstanding in the balloon debt at the end of the loan period.”
Additionally, WesBank said that you should not view a balloon payment as an alternative to an upfront deposit.
“A healthy deposit on a new or used car will always reap returns further down the financial road.”
“Not only will it bring your breakeven point forward, but it will also lower the monthly repayment costs and the deferred debt held in the balloon. You also won’t be liable for additional debt at the end of the finance period.”
A practical example
WesBank provided an practical example of how a balloon payment works:
- A vehicle purchase price is R300,000.
- A buyer defers 10% of this into a balloon payment.
- The monthly repayment will be calculated on a price of R270,000.
- The balloon sum of R30,000 will need to be settled at the end of the contract term.
WesBank reiterated that while the balloon payment in the example plays a similar role to a deposit, the difference is that “the buyer needs to save the R30,000 while paying off the loan”.
It is therefore important not to view a balloon deal as a means to purchase a car you cannot afford.
“A looming lump sum payment after years of driving a vehicle is easy to ignore and forget. But settling that debt ultimately remains the responsibility of the buyer.”