What is a car balloon payment and how does it work?

When it comes to financing a new or used car, it’s best to understand what you’re signing up for before you apply. Finance options such as a Personal Contract Purchase (PCP) agreement will be subject to what’s called a ‘final balloon payment’ if you wish to own the vehicle at the end. 

It’s important you’re up to scratch with these types of finance terms so you can make an informed decision. To clear things up, we’ve put together this handy guide to explain what a car balloon payment is and how it works. Read on to find out more…

What is a car balloon payment?

A ‘balloon payment’ is the term used to describe a lump sum amount of money which is due to be paid at the end of a finance agreement in order to own the car. As the name suggests, a balloon payment is a larger amount of money owed compared to the previous monthly payments that would have been made.

The idea of a balloon payment is to minimise the fixed monthly fees a person will pay when borrowing money from a lender, such as finance for a car. This is then offset by the larger amount paid at the end of the agreement known as the balloon payment.   

Is a balloon payment the same as an optional final payment?

To help clear up any confusion when it comes to car finance lingo, a balloon payment is also referred to as an ‘optional final payment’. Both relate to the amount of money you owe as the last payment of a finance deal in order to formally own the car. 

How does a car balloon payment work?

As any car owner knows, a vehicle depreciates over time which means the monthly amount you pay back for vehicle finance is actually the cost of a car’s depreciation during the agreement term, rather than paying off the value of the car.

This means the balloon payment amount instead relates to the value the car has retained during the period of finance - this is why it is larger than the monthly amount you will have been paying throughout the course of the contract. 

You may have heard of the term ‘Guaranteed Minimum Future Value’ (known as GMFV for short) which is a set amount of money confirmed at the start of the agreement. The term refers to the predicted depreciation of a car by the lender and will influence the final balloon payment amount owed by the borrower. 

Of course it’s not possible to predict the exact amount a car will depreciate over time, so it could be that the financed vehicle depreciates more or less than predicted. However, this will not influence the balloon payment amount, which will have already been agreed before the contract began and is fixed at that amount.       

How is a balloon payment calculated?

The way that balloon payments are calculated is by working out the difference between the purchase price of the car (how much it is worth), minus the deposit and total monthly payment amounts you’ll make towards the vehicle during the course of the agreement, factoring in the Guaranteed Minimum Future Value too. 

What you need to know as the borrower is that in essence you are really only paying the cost of the predicted depreciation of the car during the contracted period (less the deposit of course). Below, we’ve given you an example of a balloon payment… 

Balloon payment example

So that you can better understand how a balloon payment is calculated, here is an example of how it would work if you purchased a car through finance. For argument's sake, let's assume the following points: 

• The car you wish to finance costs £40,000 from new
• The lender offers you a 4-year/48-month contract with 0% interest (this rate is used in the example to simplify the calculation of the balloon payment, however you will be charged a representative APR for car finance)
• You put down a £10,000 deposit
• The expected value (GMFV) of the car after 48-months is £20,000
• Your monthly repayments work out at £277,77

Based on the information above, here is how the balloon payment will work out:

• + Start with the purchase price £40,000
• - Minus the deposit of £10,000
• - Minus the 48 monthly payments amount of £13,332
• = Equals a final balloon payment of £16,668 left to pay   

What happens when the balloon payment is due?

Depending on the type of finance deal you’ve entered into, you will be left with one of the following three options at the end of your contract when the final balloon payment is due:

1. Settle up and pay the remaining balloon payment in order to own the car outright
2. Choose to hand back the car and if the vehicle is worth less than the remaining balloon payment, the finance agreement will end
3. Sign-up to a new finance deal against the balloon payment in order to fulfil the final amount owed to the lender - this is known as refinancing 

Can a final balloon payment be paid off early?

Yes, you can pay off a final balloon payment early, unless stated otherwise in your contract. If you hope to pay off the balloon payment on your car earlier than expected, it’s best to check with the lender first. 

In order to reduce the final balloon payment, the ideal way to do this is to preempt that you’ll want your final payment to be lower, which means you’d make larger monthly repayments during the agreement term.

Is it a good idea to finance a car with balloon payments?

When asked the question whether it’s a good idea to finance a car with balloon payments, it really does depend on your individual circumstances. If you wish to own the car at the end of the finance agreement, then this will likely be the only option for you. A healthy deposit and favourable interest rate will help keep the optional final payment down. 

Always make sure you can keep up with the monthly repayments when you enter into a car finance agreement. Even if your circumstances were to change, you are bound by the contract to repay the money owed to the lender. 

What happens if I can’t pay the balloon payment on my car?

The short answer to this question is that if you can’t afford to pay the final balloon payment on your car loan, the lender will take the vehicle away. As the registered owner throughout the duration of the agreement, the finance company is well within their right to take the car back at any time if payment terms aren’t met by the borrower.      

What are the advantages and disadvantages of a balloon payment?

As with any finance deal, there are of course advantages and disadvantages to entering into such a contract - and car finance is no difference. So you can make a properly informed decision before you enter into a contract, it’s best to weigh up the pros and cons. 

To help, we’ve highlighted the most important advantages and disadvantages of agreeing to car finance with a balloon payment:

What types of car finance have a balloon payment?

The car finance deals most associated with final balloon payments are Personal Contract Purchase (PCP), Hire Purchase (HP) and Lease Purchase (LP) options. Each of these finance solutions works slightly differently but have one thing in common; if you wish to own the vehicle at the end of the agreement, you will need to settle with the lender by paying a final balloon payment before you formally become the registered owner.  

Explore car finance solutions at Octane Finance

Don’t let the search for car finance get stressful - our team of friendly finance experts will help you navigate the road to vehicle ownership. At Octane Finance, we work with you to identify the best form of car finance and as a leading broker in the UK, we can secure the best deal possible. 

Why not put yourself in the driving seat by seeing how much your monthly repayments could be on your next car. Head over to the finance calculator page to discover what PCP and HP deals are available to you right now.