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A balloon payment car loan works quite differently than the standard auto 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?
A balloon auto loan has pros and cons. What is balloon payment on a car? It’s 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.
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, 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)
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
$912
$456
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.Some states may give you the right to refinance a balloon auto loan, including Texas and Illinois. If you don’t live in one of those states, you may want to consider a backup plan in case your balloon refinancing request is denied and you need to take another course of action.
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
Options for Dealing With a Balloon Payment
Below we highlight 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 states may give you the right to return the vehicle as an alternative to making the large balloon payment. These states include Illinois, Maine, New Hampshire, and Texas. Lenders in some of these states may impose certain fees if you return the vehicle as an alternative to making the balloon payment.
Refinancing
Certain states may give you the right to refinance a balloon auto loan as an alternative to making the large balloon payment. As mentioned earlier, Texas and Illinois are among those states. If you don’t have the right to refinance a balloon auto loan in your state, you may want to consider a backup plan. Unless required by law, there’s no guarantee a lender will approve your balloon refinancing request.
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. If you have the right to refinance your balloon auto loan, you can plan to exercise that right as an alternative to making a balloon payment.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.
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. Some states may give you the right to refinance a balloon payment car loan, but that right is not universal. Having a backup plan might be helpful if your balloon refinancing request is denied.
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 be comparing 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 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.Recommended: Car Loan Terms Explained
Auto Loan Refinancing Rates
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 auto refinancing, either to pay off a balloon payment or for other reasons, simply fill out one application at Lantern by SoFi and select an offer that may be right for you.Find and compare auto loan refinance options with Lantern.
Frequently Asked Questions
Is a balloon car loan a good idea?
Can you pay off a balloon car loan early?
Can you pay off a balloon payment in installments?
Photo credit: iStock/ISvyatkovsky
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About the Author
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.
