A friend posed a question to me on Friday whether or not to consider a balloon payment offered by the bank to buy a car. I am glad she asked because it is that time of the year again. Every year, normally at the beginning of the year, banks in Namibia has Zero deposit deals. These deals allows customers to buy cars without a deposit on a condition that they will pay a particular lump sum at the end of the loan term.
Here is an example I found on the internet that explain in simple terms how a balloon payment works:
If you took out a five year loan on a R 200 000 car, and elected to have a 25% balloon payment, you would need to pay the residual 25% (R50 000) in a lump-sum at the end of your loan term. Your monthly installments would then be based on R150 000 instead of the full R200 000 which means you’ll have a much lower monthly repayment fee.
It’s similar to the deal where you have put up a deposit, however instead of paying the lump sum upfront, you get to defer the payment of the deposit to the future. The problem with this is that, it is almost saying that you are sure in 5 years time you would have money because you will be in a favorable position than you are now. This may come true or it may be the complete opposite.
So what are the advantages of taking out balloon payment:
- You get the car now that you would otherwise have to wait and save for.
- Because of the fact that your monthly installments will be calculated on the amount after the balloon payment, it means that you get to pay a lower installment.
On the disadvantage side of things :
- You might want to consider if you are not living above your means and maybe are not making an impulsive decision. If you knew you wanted a car, why are you not able to save for a deposit? Just give it some thought.
- You are banking that you will be in a better position in a few years from now. What if this not the case? Will you have other commitment that you will be able to meet in addition to saving for that lump-sum? Maybe married with kids ?
- There is no such thing as a free lunch. The bank will charge you interest on that lump sum and in the end you will add up paying double the amount you could have paid upfront.
So what now? The key question here is to ask yourself why you are in a hurry to get a car? A car debt is a long term commitment so I suggest that you give it some thoughts before committing. In addition, you should also be looking at other costs that comes with owning a car such as insurance, petrol and maintenance.
If you are unsure, also check out my article on whether you should buy new or used car that may help in making this decision .