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What Is a Balloon Auto Loan? How Does It Work?

What Is a Balloon Auto Loan? How They Work
Kelly Boyer Sagert

Kelly Boyer Sagert

Updated December 29, 2021
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A balloon payment auto loan works quite differently than the standard vehicle loans that many people are used to getting. 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.

What Is a Car Loan With a Balloon Payment?

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 vehicle 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.

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 from 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 versus traditional auto loans stack up, we’re going to do 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 4.50%. (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, we’ll assume 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 $912. 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 $456. 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.Traditional Car Loan vs. Balloon Auto Loan (Based on Above Example)

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 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 ($912 in our example) and the balloon one ($456 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.

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. Remember there’s no guarantee that you’ll qualify for refinancing when the balloon loan period is over.

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 balloon payment, refinancing also can be an option. You may decide to refinance with the same lender again, or you may be comparing loan programs among lenders. In either case, take into account the cost to refinance.Before refinancing, it’s also important to take into consideration refinancing your car pros and cons. 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.

The Takeaway

When buying a vehicle, a balloon loan is structured differently from a more 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.If you’re looking into automobile refinancing, either to pay off a balloon payment or for other reasons, simply fill out one application at Lantern by SoFi to receive multiple offers from lenders in our network.
Photo credit: iStock/ISvyatkovsky
The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.SOLC112206

About the Author

Kelly Boyer Sagert

Kelly Boyer Sagert

Kelly Boyer Sagert is an Emmy Award-nominated writer with decades of professional writing experience. As she was getting her writing career off the ground, she spent several years working at a savings and loan institution, working in the following departments: savings, loans, IRAs, and auditing. She has published thousands of pieces online and in print.
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