What is a Car Balloon Payment?

Most car shoppers should avoid auto balloon loans since they require a large payoff down the road. But this kind of financing still exists for a reason. Some people can benefit from a car balloon loan.

How do auto balloon loans work?  

Repaying a balloon loan for a car starts slowly, saving money for car buyers at first. The loan begins with lower payments than ordinary car loans. 

But then, the payoff pace accelerates quickly. In fact, the full loan amount comes due at one time, usually within two to three years.

The table below shows the difference between a 3-year balloon loan and a 5-year traditional loan, both for $30,000.

$30,000 loan size	3-year balloon loan (10% APR)	5-year traditional loan (9% APR)
Payments 1-35	$489	$623
Payment 36	$20,000 balloon payment	$623
Payments 37-60	N/A (loan no longer exists)	$623

Over the first 35 months — which is almost three years — the buyer in this example saves $134 a month, despite borrowing the same amount of money and paying a higher interest rate. Over those 35 months, the buyer saves a total of $4,690.

However, when the balloon loan reaches month 36 — the end of its third year — the buyer must come up with $20,000 to pay off the full loan balance. 

What happens if you can’t make the balloon payment?

Borrowers who can’t afford to make their balloon payment at the end of the loan can find alternatives, all of which come with pros and cons:

Solution	Pros of solution	Cons of solution
Refinancing balloon payment	Continues affordable monthly payments	Restarts interest; new loan can’t exceed car’s value
Selling the car to pay off the balloon loan	Eliminates the debt	Eliminates the car too
Trading in the car	Get a new car	New car likely costs more and will need new financing
Negotiating for an extension of the balloon loan	Buys time	Not guaranteed to work; lender has no obligation
Using a personal loan to make the balloon payment	Could work even if car loan is “upside down”	High interest and high monthly payments
Using a home equity loan or line of credit to cover balloon payment	Lower interest rates	Ties up home equity and places a lien on home
Using a cash-out refinance to pay off the balloon loan	Eliminates the debt	Removes equity from your home

Whether a borrower can sell or refinance the car to cover its balloon payment depends, in part, on the value of the car. 

Using a Cash-Out Refinance to Pay Off Your Car Balloon Payment 

If you own a home, one source of funding is the equity in your home. You may be able to open a bigger mortgage than you have currently and use the proceeds to pay off your car loan.

For example, you owe $250,000 on your home. You open a cash-out refinance of $275,000 and have $25,000 in cash, less closing costs, wired to you at closing. You can use these proceeds for any purpose.

Your resulting mortgage rate might be lower than your auto loan rate. And, you spread the payment out over 30 years, reducing the monthly payment.

However, you will incur high closing costs with this strategy since mortgage refinances cost 2-5% of your home loan amount to pay for fees like the appraisal, title, and lender points. You also will pay more interest over the life of the loan since you essentially pay off your car over 30 years instead of the typical five to seven years.

Still, a cash-out mortgage could be a reasonable solution if you have no other options.

Various types of cash-out refinances include:

• Conventional cash-out
• FHA cash-out
• VA cash-out
• Home equity loan or line of credit 

The Danger of Being “Upside Down” on an Auto Balloon Loan

Unlike houses and condos, which usually gain value as time passes, cars lose value. When a car’s value falls below the amount due on its loan, the borrower becomes “upside down” on the loan, also called being “underwater.” 

Going upside down is more likely with a balloon loan since a balloon loan’s principal balance tends to decrease slower than on a traditional loan. 

Of course, different cars depreciate at different rates. Some 3-year-old cars, still in excellent shape with moderate mileage, can hold onto more of their original value. But there’s no guaranteeing that. 

Most buyers who find themselves upside down on their loans can’t sell the car for enough money to pay off the loan. They have to come up with cash to close the gap between the car’s value and the balloon payment, complicating the process.

Refinancing an upside-down car is also tougher. Typical auto lenders won’t loan more than the car’s value. If they will, they usually cap loan size at 105 percent of the car’s value.   

Why would someone choose an auto balloon loan?

Who would choose an auto balloon loan with its huge payment on the horizon? A variety of car buyers can benefit from this kind of financing, including:

• People who can make the payment: Some people have enough cash in the bank to make the balloon payment when it’s time. They can enjoy the balloon loan’s lower monthly payments — investing the savings elsewhere — without stressing about its upcoming payoff date. 
  
• People who plan for the payment: A buyer who plans to refinance or sell the car within two to three years sees the balloon loan as temporary from the beginning. These types of buyers often make down payments to help keep the loan right-side-up.
  
• People whose cars shouldn’t lose value: Borrowers buying classic cars or vehicles they plan to restore won’t be too worried about depreciation. They can use a balloon loan, knowing the car should appreciate in relation to the auto debt.
  
• People who may buy a home soon: The initial low monthly payments on a balloon auto loan can help some home buyers qualify for a larger mortgage. Lenders compare monthly debt to income (DTI) to see what home buyers can afford.
  
• Businesses: Businesses that maintain fleets of cars can use balloon loans to increase monthly cash flow. Then, they use another source of revenue to pay off the loan when it’s due. 

All the borrowers above use the savings from the balloon loan strategically. They also have a plan for paying off the loan before they even open it. 

Balloon Financing vs. Leasing Your Car

On the surface, car balloon loans may sound a lot like leasing a car. Both auto balloons and leasing can save drivers money each month for a while. 

However, leasing a car resembles renting an apartment. The monthly lease payments — and the cash paid to the car dealer upfront — allow the lessee to use the car. The lessee never owns equity in the car and can’t sell it because the car remains the property of the dealership.  

Leases also require drivers to limit their mileage, often 10,000 or 12,000 miles a year, or face steep penalties at the end of the lease.

What do balloon financing and leasing a car have in common?

For balloon financing and car leases, the savings come with a built-in expiration date: 

• For balloon loans, the deadline strikes when the balloon payment comes due at the end of the loan’s term.
  
• For leases, the deadline comes at the end of the lease, usually ranging from two to four years. 

At the end of a balloon loan, the borrower can pay off the loan balance or sell or refinance the car. At the end of a lease, the driver can renew the lease, lease a newer car, or buy the leased car at its current value.

Where To Find an Auto Balloon Loan

Several automakers’ in-house financing departments, including Hyundai’s and Ford’s, offer balloon loans for new cars. But most buyers who want this kind of loan can get a better deal when they find financing on their own.

Shopping for financing independently of the car dealership lets buyers compare interest rates, fees, and terms rather than accepting whatever offer the car dealer presents. Borrowers who compare rates and fees increase their chances of finding the best deal.

A variety of independent lenders, from online-only lenders to local credit unions, offer auto balloon financing to consumers.       

Auto Balloon Loan Alternative: Home Equity Financing

Using a home equity loan to finance a car looks attractive to people who are trying to save money on car payments. Here’s how it can work if you own your home:

1. Measure home equity: A mortgage lender appraises the value of your home. If the home’s value exceeds your mortgage debt, you have home equity. For example, a home worth $300,000 with a $200,000 loan balance would have $100,000 in equity.
   
2. Find out how much equity you can use: You need to leave some equity in the home — usually 15 to 20 percent. For the example home above that appraised for $300,000, 20 percent equals $60,000. Combining that $60,000 with the existing $200,000 loan balance means $260,000 of the home’s value is already spoken for. That leaves $40,000 in equity available to borrow.
   
3. Borrow the cash: A home equity loan or a home equity line of credit from a mortgage lender lets you access the available home equity which you can use for any purpose, including buying a car. You’ll have to qualify for the mortgage with your credit score and income.
   
4. Make the payments: Keep paying your existing mortgage payments as usual — and start making the new “second mortgage” payments too.   

The benefit to this strategy? Low car payments. Since your home’s value secures the loan, lenders can afford to charge lower interest rates — rates comparable to today’s mortgage refinance rates. Plus, lenders can spread debt across a longer term which lowers monthly payments.

What’s the catch? Taking on more mortgage debt and placing a new lien on the home. If your finances fell apart and you couldn’t afford to make the loan payments, the lender could foreclose on your home. Many car buyers, understandably, don’t want to put their homes on the line for a car.