Is a balloon the same as a residual?

People use the words in much the same way. "Balloon" usually means the final lump sum on a loan, such as a chattel mortgage or car loan. "Residual" usually means the final payment on a lease. On car leases, the ATO has guidelines on minimum residual values, which don’t apply to loans.

How big can a balloon be?

Each lender sets its own limits. Many use a sliding scale: the shorter the term and the newer the vehicle, the bigger the balloon they may allow. I’ll tell you what each lender allows.

Can I pay the balloon off early?

Often you can, but some loans charge a fee for paying out early. Check the loan contract, or ask me before you sign.

Some car makers' finance companies offer loans with a balloon and a set minimum value for the car at the end (often called GFV). That value only applies if you meet the conditions, such as agreed kilometres and fair wear and tear. Read the conditions carefully before you sign.

Is a balloon better for tax?

A balloon changes how much interest you pay and when. How that affects your tax depends on your situation. Speak to your accountant.

Balloon payments explained: the good and the bad

Balloon payments come up in almost every vehicle and equipment loan I arrange. They can be a smart tool. They can also be a nasty surprise at the end of the loan if nobody explained them properly.

Here is the plain-English version.

How a balloon works

With a normal loan, each repayment pays off a little of the amount you borrowed, plus interest. By the last repayment, you owe nothing.

With a balloon, you agree to leave part of the loan unpaid until the end. That part is the balloon. Because you’re paying off less along the way, each repayment is lower. Then, at the end, you pay the balloon as one lump sum.

A balloon is usually set as a dollar amount or as a percentage of the price, such as 20% or 30%.

An example

Take a $50,000 ute over five years, at the same interest rate both ways:

	No balloon	30% balloon ($15,000)
Monthly repayment	Higher	Roughly a fifth lower
Total interest	Lower	About a quarter more
Owing at the end	Nothing	$15,000

The exact numbers depend on your rate. You can try your own in my repayment calculator. Switch the balloon on and off, and watch the repayment and the total change.

The good

Lower repayments. This can free up cash flow for the rest of your business or household budget.
A planned upgrade. If you expect to trade the vehicle in at the end, a balloon can be set close to what you expect it to be worth.

The bad

More interest overall. You’re borrowing more of the money for longer, so you pay interest on it for longer.
A big bill at the end. The balloon is due on a set date. You need the cash, a new loan, or a sale lined up.
Owing more than it’s worth. Vehicles and machines lose value. If yours is worth less than the balloon at the end (for example, because of high kilometres or hours, or damage), you’ll need to make up the difference. Selling it doesn’t clear the debt if the sale price is too low.
Refinancing isn’t automatic. If you plan to refinance the balloon, the lender will assess you again at that time.

Your options when the balloon falls due

Pay it. Use savings or business cash flow, and the vehicle or machine is yours outright.
Refinance it. Take out a new loan for the balloon amount. You’ll pay more interest, and it depends on approval at the time.
Sell or trade it in. Use the sale money to pay the balloon. If it sells for more, you keep the difference. If it sells for less, you pay the gap.

If you have a balloon coming up, call me well before it’s due. There’s more choice when there’s time to plan.

How I’d think about it

A balloon can make sense when you have a clear plan for the end of the loan. It is risky when it’s only used to make repayments look smaller.

A good test: set the balloon at or below what you honestly expect the vehicle or machine to be worth at the end. Then put a note in your calendar a year before it’s due.