Balloon Lease Explained: Smart Car Financing Options to Consider

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Whether you finance or lease, you may have the option of a “balloon payment” at the end of the term. A balloon payment on a car is a large payment due at the end of the loan or lease term.

When you lease a car, you make monthly payments, but return the vehicle at the end of the term, typically three years.

Here’s an overview of what you might expect with a balloon lease.

What Is a Balloon Payment? 

A balloon payment is a larger lump sum that becomes due when a loan or lease term ends.

A balloon payment on a car could be as much as 50% of the total loan or lease amount. If you can’t afford it, you can take out another loan to cover the costs or sell the vehicle to pay off the loan.  

How Do Balloon Payments Work? 

Balloon payments work by deferring a portion of the principal amount until the very end of the loan, which allows for smaller monthly payments throughout the term.

Balloon Payments: Loans vs. Leases  

You can apply for a balloon option with a car loan or with a lease. There are advantages and disadvantages to both choices, though.

A balloon payment at the end of your term tends to be risky. It’s not the best option for everyone. But it can help you afford a more expensive car and still keep your monthly payments low.

Balloon Car Loans 

When you take out a balloon car loan, you must make the final payment before ownership will be transferred to your name. The difference between a regular loan and a balloon loan is that the final payment on a balloon loan will be much larger.

If you can’t make that final payment, you may have to refinance the remaining car loan balance, take out a new loan or even sell the car.

Keep in Mind

Read your auto loan contract carefully to understand your options when the loan term ends.

If your car has depreciated in value, you might still owe money on the loan even after you sell the vehicle. That’s why balloon loans are more often used for antique or classic cars that are more likely to gain, not lose, value.

Balloon Lease: Lease with Purchase Option  

You can also have a balloon payment at the end of a lease. Sometimes, this payment is the predetermined purchase price to keep the car. Once you make that final payment, the title will be transferred to your name. With a lease, you might have the option to forego that final payment and turn in the car to the dealer or leasing company.

A balloon payment lease or a lease with an option to buy differs from a closed-end lease. In a closed-end arrangement, you always have the option to turn in the car at the end of the leasing period. You might even be able to negotiate a lower buyout price, especially if your car is worth a lot less than the buyout price on your lease agreement.  

Advantages of a Balloon Payment Structure 

In spite of the risks and larger lump-sum payment at the end, a balloon payment offers some financial advantages.

Lower Monthly Payments 

If you’re looking to buy a more expensive car and keep monthly payments low, a balloon payment arrangement allows that to happen. This can be advantageous especially if you expect your income to increase substantially by the end of the loan.

For instance, if you’re currently a doctor working at a residency while you gain experience, you might expect your salary will increase once you complete your training. Likewise, a college student entering a field like law may expect to make more money after they graduate.

Financial Flexibility 

 By deferring the payments, your money can work for you through other investments. Since you’re likely taking out a simple interest loan, if you can invest your cash and earn more than the interest on the loan, it makes sense to keep that money. You can even start a high interest savings account and set aside fixed amounts so you know you have the balloon payment funds in the bank when the loan comes due.

Drive a Newer or More Expensive Vehicle 

A balloon payment loan or lease may allow you to choose a newer or more expensive car. Newer cars often have better safety features and higher reliability, which can provide peace of mind and help you save money on repairs.  

Disadvantages and Balloon Car Loan Dangers 

While the advantages make balloon loans seem enticing, there are some issues that make a balloon loan a financial risk.

The Last Balloon Car Payment 

You’ll have to be prepared for that last payment on your balloon loan or lease. If you can’t make the payment or sell the car to pay off the loan, the lender will repossess the car, leaving you with a black mark on your credit reports and nothing to show for your years of loan payments. If you have to sell the car, it might leave you short of cash to purchase another vehicle.

Risk of Negative Equity 

If you need to sell the car to make the balloon payment and the car’s market value has dropped below the price of that payment, you’ll need to make up the difference — either out of your own pocket, using a credit card, or borrowing the money somewhere. Even if you decide to make the payment and keep the car, that means you’re paying more for the car than it’s worth at that time.

Potentially Higher Overall Cost

Balloon loans often come with a higher interest rate than other auto loans, because of the risk of borrowers defaulting when they can’t make that large payment.

Credit Implications 

If you can’t make that final payment, the car could be repossessed. A repossession or voluntary surrender of a vehicle stays on your credit report for seven years from the date of the first missed payment, according to Capital One. A repo can also lower your credit score by 100 points or more, according to Upsolve.org, a nonprofit debt relief firm.

End-of-Term Options for Your Balloon Payment 

When you reach the end of your term, you have options to cover that balloon payment.

• Pay the balloon in cash: If you make that final balloon payment on a loan or lease, you’ll own the vehicle outright.  
• Refinance the balloon: You can take out a new loan to cover the balloon payment and continue making monthly payments on the car.   
• Sell or trade in the vehicle: Assuming the car’s value hasn’t dropped below what you owe, you can sell or trade in the vehicle and use that money to satisfy the balloon payment. You might even have enough equity to use some of the car’s value on a down payment for a new vehicle.
• Return the vehicle: If your leasing agreement allows, you might have the option to return the vehicle, as long as you cover any lease-end charges or extra fees for damage, over-mileage or wear-and-tear.

3 Alternatives to Balloon Payments 

A balloon payment carries many risks. It might be better to consider these alternatives.

1. Traditional Auto Loans 

A conventional auto loan, written through the dealer’s financing company or a third party, provides equal monthly payments across five, seven or 10 years. This makes it easier to budget. While the average auto loan interest rate for a new car ranges from 11.87% up to 20.17%, depending on your credit score, you may be able to secure 0% financing through a dealer if you qualify.

If this is your first vehicle purchase and you have no credit history, you may be able to get a loan without a credit check from a used car dealer.

2. Standard Leases 

A conventional lease allows you to walk away at the end of the two- or three-year term. You’ll be responsible for lease-end fees and paying for any mileage that exceeds your agreement or unusual wear and tear on the car. But you can avoid the balloon payment and at the end of your lease, you can lease another car.

3. Swap Leasing 

Swap leasing allows you to transfer your lease to another person. This provides flexibility if you are one or two years into the lease and decide you want a different car. You can also avoid a balloon payment on your lease by transferring the lease before that last payment is due. The other person may enjoy the benefits of a shorter lease and no down payment.

Final Thoughts on Choosing the Right Financing for Your Car

Balloon payments can be a risky financial decision, since you’re essentially counting on having a large sum of money available that you didn’t have when you chose the vehicle. It can work out if you expect your pay to increase. It can also free up cash flow for other investments or business decisions.

Make sure you understand the contract terms and have a plan in place for that large final payment. If you’re struggling with money or not sure of the best financial decision, it can be worthwhile to consult with a financial advisor to help you determine your best money moves.

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