A residual value or balloon payment is a term originating from lease agreements. The residual value is a forecasted depreciated value of your asset at the end of your lease term. The residual values have set guidelines in place for motor vehicles from the Australian Taxation Office and in most cases with lease agreements, residual values are mandatory.
A balloon payment is the term used for other finance structures, such as a Chattel Mortgage, Commercial Hire Purchase (C.H.P.) or a Consumer Loan. A balloon payment is similar in the sense it is an offset amount from the purchase price of the vehicle left as a last repayment at the end of the term of your car finance. However, the main point of difference is the flexibility of the balloon amount. Unlike lease agreements, balloon payments are not essentially forecasted depreciated values of the vehicle, which this allows you to often select the size of your balloon payment, normally anywhere from 0-20%.
Should you use a balloon payment?
The main benefit is to reduce your monthly instalment, leaving the large offset amount as a last payment, where the borrower has the flexibility to refinance the balloon, pay it as a cash lump sum, or the most common, would be to trade the vehicle in, upgrading whilst aiming to have the balloon paid out with their trade value.
As you are offsetting your monthly repayments by having a balloon, this would increase the total amount of interest payable slightly over the full term of the car loan, as you are paying less principal off the loan with each repayment by having the balloon offset at the end. This can sometimes be the aim if you are using the vehicle predominantly for business use, as the principal is not deductible, where your interest may be. If it is for personal use only, you would pay more interest over the full term with the main benefit being the reduction in monthly repayments only.
The other fact that needs consideration is that with a balloon repayment, if you had some period throughout your loan term, where you were unable to pay your payments on time, the lender may not refinance your balloon payment when it is payable, and may also give you a poor reference to other lenders that would have considered refinancing your balloon or financing your new purchase. You may be forced to sell your vehicle to payout your balloon payment without the ability to finance a new car, whereas if you took out a loan without a balloon payment, you would own that vehicle at the end of the term and not be in this position. Some uncontrollable circumstances arise that this could be a real possibility and needs careful consideration when requesting to take out a loan with a balloon payment.