What is a balloon installment?
In general, loans and credits incurred are paid back in equal or decreasing principal and interest installments. Less often, the third type of repayment is used, i.e. a loan with a redemption installment, known as the so-called balloon installment.
This is a special form of repayment. It consists in the fact that the customer pays only interest throughout the entire loan period, while the principal amount and the last interest portion is repaid in the last and highest installment. Due to the fact that the initial installments are low, the repayment schedule only slightly burden the borrower’s household budget.
The repayment time is usually quite long, but the borrower must be prepared for higher interest than with the traditional method of repayment. Importantly, this repayment schedule allows you to increase your creditworthiness. This is because the balloon installment is not included in the loan amount.
Credit installment loan and traditional loan – differences
The balloon installment offered by some financial institutions is a convenient and most often used solution when buying new cars. Car loans offering this method of repayment are granted by some universal banks and the so-called autobanks, i.e. institutions associated with car manufacturers and importers.
There are several aspects to these two ways of financing. These include
- Procedures – in both cases, the customer’s creditworthiness, his bank scoring and no entry in the debtors’ databases are important. However, when using AutoBank services, we have the option of obtaining financing directly at the car showroom, which significantly shortens the procedures for granting financial support.
- Subject of the contract – car loan is beneficial when buying a new car for a long time, while a balloon loan is profitable for people who do not want to buy a car for many years. Including such a commitment, we pay a monthly fee for using a new car that is not our property (but at the end we can buy it from the bank).
- APRC – the average interest rate on a traditional loan is around 7 percent, and commissions can reach up to 15 percent. Sometimes a fee for starting a loan is also required. On the other hand, the balloon installment has higher total costs due to the fact that the bank bears a much higher risk than with a traditional car loan.
- Installments – a traditional car loan involves monthly installments for a similar amount, while the balloon loan is repaid in asymmetrical, much lower (up to 40% compared to a “normal” loan) monthly installments and the last large balloon installment.
- Repayment schedule – classic bank loans are repaid in the traditional way, i.e. in equal or decreasing installments throughout the loan period. At the balloon installment, the customer first pays own contribution in the form of e.g. 10% car values. The next several dozen percent is repaid in monthly installments, and finally the last largest installment is regulated.
Taking a balloon loan, many people are worried about how they will manage to pay their last installment. Borrowers have the opportunity to pay their debts in three ways. They can:
- return the previously used car and replace it with a new one as part of another balloon contract,
- keep the car being credited and pay the last part in installments,
- stop the credited car and pay the last part of the liability once from your own funds.
What are the benefits of a car loan with a balloon installment?
The balloon installment is most often used for car loans, in which at the beginning you pay about 10 percent. initial payment, and later low monthly installments made solely of interest. At the end of the loan period, the so-called installment with redemption.
Sometimes using this form of debt settlement involves paying up to half the value of the car. It works similarly to own contribution, except that it is paid at the end of the loan agreement. The longer the loan agreement lasts, the lower the redemption percentage is at the end of its duration.
Replacement of the car in a balloon installment – a new car for a loan every few years
Another plus is the fact that the customer can replace the car with a new one at the end of the loan. At the end of the contract, the borrower may resell the car and use the amount to pay the last installment or own contribution when taking out a loan for another car with a balloon installment. Thanks to this, he will be able to have a new car for the next few years.
Importantly, the dealer guarantees the car to be bought at market price. Therefore, the customer does not have to pay extra or worry about selling the car on the secondary market. What’s more, if the customer changes the car every three years, he will be able to use a new vehicle covered by the warranty and promotional insurance packages.
If the borrower wants to stop the car, the last part of the commitment can be divided into installments. Using this option may result in the cost of another loan being incurred.
How will the balloon installment affect the APRC of the loan?
The balloon installment guarantees a lower monthly installment than a traditional loan. However, a bank deciding to use this form of repayment is at high risk. Therefore, the APRC for a loan with a balloon installment may be higher than for a standard loan. Due to the lack of regular repayment of part of the capital made available, the financial institution may require collateral in the form of a larger margin or registered pledge.
The amount of installments during the loan period can be calculated using the balloon installment calculator or (if the loan interest rate is fixed) it can be calculated using the formula below:
R- installment payment,
K – loan amount,
p – loan interest rate,
d – the number of days to which the installment payment relates.
Whereas the last installment may constitute 20 – 50 percent. the value of the vehicle being credited. Its amount depends mainly on the lender’s policy, the value of the vehicle and the loan period – the longer the lower the amount to buy the car. The balloon installment is determined according to the formula:
Rb – installment payment,
K – loan amount,
p – loan interest rate,
db – the number of days to which the last installment (interest) payment relates.
Loan installment loans are more favorable in terms of installment amounts. The monthly cost of repayment of such a liability is even several dozen percent lower than in the case of a traditional cash loan. Interestingly, repayment of the last installment in cash is not mandatory. The buyer of the vehicle can get rid of the debt by simply giving the credited car to the salon.
Car loan insurance with balloon installment
The loan repayment insurance with a balloon installment works on similar principles as the standard loan insurance, and thus it is not obligatory. The advantages of insurance include a sense of security in paying off liabilities in the event of temporary financial problems.
The scope of insurance usually includes the death of the insured person as a result of an accident, the total and permanent incapacity of the insured person to work as a result of an accident and an insurance event that may occur worldwide.
The fee is charged once for the entire loan period – it starts from the day the loan is released and lasts for about 12 or 24 months. The insurance amount is part of the non-interest loan costs that raise the APRC.
The amount of the insurance fee depends on several factors. These include, for example, the amount of the loan, the repayment date, the borrower’s age and the extent of the situation to be secured. In addition, the price of insurance is also influenced by the type of repayments – it will be different for loans repaid in one annual installment and different for those repaid in two annual installments.
Disadvantages of balloon installment – what to watch for when taking out a balloon loan?
No financial commitment is perfect. When deciding to take out a loan with a buy-out installment, pay attention to all its aspects, including the negative ones. Among the disadvantages of the balloon installment are:
- a good credit history is needed,
- own contribution sometimes required at the beginning of the contract, most often it is one-tenth of the value of the car,
- higher interest rate and APRC for loans with a balloon installment compared to a standard loan,
- the need to accumulate a significant amount for the last balloon installment,
- interest is charged on the entire capital throughout the duration of the contract.
What instead of a balloon installment – car loan and car leasing
A car loan can also help you get money for your dream car. We have several loan companies on the market with just such offers in their range. They are very popular due to the high amounts and the possibility of receiving money even without checking creditworthiness.
An alternative to car loans and loans may be taking a car in
consumer leasing. It is a contract addressed mainly to entrepreneurs, which allows the lessee to use the goods for a specified period of time. It is possible even with low creditworthiness, and operating leasing installments are entirely tax deductible, as a result we pay lower taxes.