What is a balloon payment on car finance?

Let’s face it; car finance probably isn’t the first thing that comes to mind when you think about balloons. For us, it’s more likely to be animals, parties, and the ones filled with hot air – not necessarily in that order.
 
So, what do we mean when we talk about a car finance balloon?
 
Balloon is the word used to describe the amount you need to pay at the end of a Personal Contract Purchase (PCP) agreement to become the car’s legal owner.
 
Ready to find out how a balloon payment might affect your next car loan? Take a deep breath and let’s dive into the details:

What is a balloon payment?

No matter whether you’re a car finance first-timer or an armchair expert, a balloon payment probably sounds a lot more appealing than its other name: the optional final payment.
 
Either way, it’s usually a lump sum owed to the lender when your car finance agreement comes to an end. You might see the term pop up elsewhere (pardon the pun), but balloons are most commonly attached to PCP agreements.
 
It also represents the value left in your car when you reach the end of your agreement and can help to keep your monthly payments low (or at least lower than they would be with Hire Purchase or HP).

Balloon payments on PCP agreements

We’re going to float an idea by you. Imagine you’ve fallen in love with a new set of wheels but you’re not sure whether it’s going to be a quick fling or a long-term thing. You’re ready to commit, but you’d like to have the chance to change your mind about owning it further down the road.

Introducing PCP finance.

PCP deals can be broken down into three main parts:

1. The deposit (but not always!)
2. The monthly payments
3. The balloon payment

The big caveat with PCP is that you don’t have to pay the balloon payment. Once the loan term ends, you can choose to pay it and become the car’s owner, hand the keys back and walk away, or use any available positive equity that you might have built up over the course of the agreement as a deposit in your next deal.

Carmoola currently doesn’t offer PCP finance however we can help you refinance a balloon payment under a new Hire Purchase agreement.

How is a balloon payment calculated?

Time for a maths lesson – but don’t panic; we’re talking addition and subtraction, not Pythagoras’ theorem.
 
The balloon payment is based on your car’s Guaranteed Minimum Future Value (GMFV).
 
In a nutshell, when the lender is arranging your PCP agreement, they’ll do a little future gazing to predict how much your car might be worth when your contract ends. It’s not exactly a shot in the dark; they’ll look at the typical depreciation rate for your car’s make and model, its fuel type, estimated mileage, and market fluctuations.
 
The lender’s prediction will be set at the beginning of your contract, and you’ll agree to pay that amount if you decide to become the car’s owner when the agreement ends.
 
In practice, this looks like:
 
You want to buy a £12,000 Vauxhall Corsa on PCP finance. You’ve agreed a term of 36 months (three years) and you have a deposit of £3,000 to put down.
 
The lender sets a GMFV of £5,000, leaving you with £4,000 left to borrow.

Deposit - £3,000
Amount to borrow - £4,000
Balloon payment - £5,000
Total amount - £12,000

What happens when the balloon payment is due?

Once you’ve been driving around in your pride and joy for the two, three, or even four years, you’ll hopefully have a better idea of whether you’re in it for the long-haul or ready to trade it in for a younger model.
 
When your loan term comes to an end, it’s decision time. You can either:

Pay the balloon payment and become the car’s legal owner (it’s all yours, baby!)

You can pay this in one lump sum if you have the cash or investigate refinancing – more details below.

Hand it back to the lender and walk away

Keep in mind you might be charged for any serious damage beyond fair wear and tear or if you’ve put more miles on the clock than expected.

Use any positive equity as a deposit in a new deal

This happens when your car ends up being worth more than its GMFV. Not only will you be quids in, but you can use these extra pennies to reduce your next loan when you part-exchange.

Refinance the balloon payment

Take out a new loan with new terms to pay off the balloon payment in monthly instalments.

Can a balloon payment change?

Once it’s pinned down at the start of your agreement, that balloon is going nowhere.
 
That’s right; whatever the amount your car’s GMFV is when you sign that paperwork, that’s the amount you’ll need to pay when the loan term ends.
 
Your car’s actual value might be higher or lower than the GMFV but that’s all part of the fun. If you do end up in negative equity this risk and associated cost is shouldered by the lender. You won’t have to pay a penny more on your agreement as long as you return the car in a state that’s covered by its fair wear and tear policy and you stick to the terms of the agreement.
 
Don’t go planning that cross-country roadtrip just yet though (even if you do have the perfect playlist ready). If you decide not to pay the balloon payment, you could face extra charges for handing the car back with a higher mileage than expected or excess damage.

What car finance options don’t have a balloon payment?

Not keen on balloons? There are other options to explore:

Hire Purchase (HP)

HP is one of the most popular types of car finance for a reason. It’s one of the more straightforward ways to spread the cost of your new wheels over time. Pay a deposit upfront (no deposit deals are available) and then make fixed monthly payments for between one and six years. Once all the payments are made (including the Option to Purchase admin fee), the car will be all yours.

Personal Loan

With a personal loan, that new car will be officially yours as soon as you’ve used the loan to pay the seller. You might need a good credit score to qualify, and your monthly payments could be higher than other options, but you won’t have to worry about mileage restrictions, wear and tear, or waiting until the contract ends to sell or part-exchange.

Personal Contract Hire (PCH)

If car ownership isn’t your thing, PCH or leasing could be the solution. Think of it like a long-term rental, you’ll make a payment each month for exclusive use of a car for one to four years. Drive carefully and keep your mileage within the limits to avoid extra charges and, once your lease ends, you can simply hand over the keys and walk away.