More South Africans are turning to balloon funds to drive off in new automobiles with decrease month-to-month instalments. But the deal comes with a catch.
“Lowering your monthly repayments can help you to stretch your salary a bit further and potentially afford a better car,” says Ernest North, co-founder of Naked, a automobile and residential insurance coverage platform. “But the lump sum on the finish of the mortgage time period is the sting within the tail.
“While a balloon payment can be a useful financial planning tool, all too many people find that they struggle to afford the final repayment.”
South African banks report that as much as one-third of automobile mortgage clients are selecting the utmost balloon fee to cut back their month-to-month repayments. North says balloon funds have turn out to be more and more well-liked in SA as a result of rising prices of residing, together with the upper prices of automobile purchases and possession.
What is a balloon fee?
A balloon fee is a lump sum that turns into due on the finish of a automobile finance time period, usually between 20% and 35% of the car’s worth, with most banks capping it at round 40%. It reduces month-to-month instalments through the time period as a result of the borrower is barely repaying a part of the mortgage quite than the total quantity.
For instance, if one buys a R500,000 automobile over six years at 10.5% curiosity with no deposit, the month-to-month reimbursement is R9,481 and not using a balloon fee. With a 40% balloon fee, the month-to-month reimbursement falls to R7,475, however a R200,000 lump sum is due on the finish of the time period. Overall, the overall price of credit score is about R682,000 and not using a balloon fee in comparison with R738,000 with the 40% balloon.
| Monthly reimbursement | Lump sum at finish (balloon fee) | Total price of credit score | |
| No balloon | R9,481 | R0 | R682,000 |
| With a 20% balloon fee | R8,478 | R100,000 | R710,000 |
| With a 40% balloon fee | R7,475 | R200,000 | R738,000 |
| R500,000 automobile, assuming 72-month time period, no deposit, 10.5% rate of interest | |||
When the balloon fee turns into due, one can:
- Pay it off in money and personal the automobile outright.
- Refinance the excellent balloon fee, which entails getting into a brand new mortgage settlement and persevering with with month-to-month repayments and curiosity fees. This choice will depend on qualifying for brand spanking new financing.
- Extend the mortgage time period, if the lender permits it, though this normally ends in greater total curiosity prices and is barely obtainable to creditworthy debtors.
- Sell or commerce within the automobile, which leaves no asset after months of funds, whereas nonetheless requiring settlement of the balloon quantity.
Balloon fee dangers
These figures and eventualities spotlight the numerous dangers and prices of balloon funds. The short-term saving on month-to-month instalments is comparatively small in comparison with the long-term publicity:
- A big money sum or new financing is required on the finish of the time period to settle the balloon fee.
- Higher balloon quantities enhance the overall curiosity paid over the mortgage interval.
- After depreciation, the car’s worth could also be decrease than the balloon fee nonetheless owed.
- Continuous refinancing each 5 – 6 years can stop full possession of a car.
- Exiting the mortgage early can set off settlement penalties together with the excellent balloon steadiness.
- In the occasion of theft or a write-off, early settlement could lead to a considerable shortfall.
- Inability to pay the ultimate balloon quantity can result in repossession of the car beneath the National Credit Act.
North says: “In idea, a balloon fee provides you the choice to pay a big money quantity on the finish of your finance time period after which you may maintain the automobile. But the fact is that most individuals don’t have that sort of money mendacity round, in order that they find yourself having to promote the automobile.
“And if the car’s value is less than the outstanding balloon amount, it becomes a very serious problem – one that many people are unfortunately facing.”
When balloon funds can work
Despite the prices and dangers, there are conditions the place balloon funds is usually a helpful monetary instrument:
- For motorists who commerce of their automobiles recurrently and are assured they’ll settle the balloon fee when it falls due.
- When revenue or financial savings are anticipated to rise over the mortgage time period, making the ultimate fee extra manageable.
- For consumers prioritising a brand new, dependable car with a guaranty, quite than dealing with unsure upkeep prices on an older mannequin.
- In circumstances the place the acquisition is made by means of a enterprise, permitting tax deductions on depreciation, curiosity, gasoline, upkeep, and doubtlessly the balloon fee itself.
- Where there is no such thing as a intention to exit the mortgage early, with a dedication to retaining the automobile for the total time period.
Guaranteed future worth vs. conventional balloon funds
A assured future worth (GFV) finance choice is usually offered as a substitute for conventional balloon funds. Under a GFV settlement, the long run worth of the automobile is mounted at the beginning of the finance time period, no matter depreciation. This quantity serves because the balloon, additionally referred to as an non-compulsory last fee.
At the tip of the time period, the client can both make the ultimate fee and maintain the automobile, commerce it in for a brand new mannequin, or return it with no additional fee required, even when the market worth is decrease than the agreed GFV. This construction reduces the chance of owing greater than the car is value on the finish of the finance interval.
With regard to utilizing balloon funds to purchase a automobile that might not be inexpensive in the long run, North says: “Rather, put down a larger deposit or choose a more affordable car. Remember, a more expensive car will also have higher maintenance and insurance costs. While it can make sense in some circumstances, the downside of a balloon payment is very seldom worth the benefit.”