Buying a car on residual or with a balloon payment may seem like an affordable way to finance your vehicle, but it’s important that you understand all the implications of the deal.
Many car dealerships offer cars on residual, with monthly payments that sound too good to be true given the make and model of the vehicle in question.
“In the short term, your monthly repayments will be low. However at the end of the repayment term, you will be left with a lump sum still owing,” says Glenn Stead, head of the personal segment at Standard Bank Vehicle Asset Finance. “This isn’t necessarily a reason not to take the offer, but you need to have a clear understanding of the process.”
A residual or balloon payment allows you to defer a portion of the amount owing on the vehicle until the end of the loan period – typically three or five years – and then pay it off in one lump sum. So if a car was valued at R200 000, you might choose a balloon option of 25%, which means that when the loan agreement ends you would be liable for a lump sum of R 50 000.
Ownership and non-ownership
There are two different types of balloon payments – known as ownership and non-ownership residuals. In an ownership situation, you are buying the car and are responsible for the lump sum at the end of the loan term. With non-ownership, the bank or lender still owns the car at the end of the loan period, and is also responsible for reselling it to cover the balloon payment. In effect, you are leasing the car from the bank. Make sure you understand which it is that you are agreeing to.
“There are benefits and drawbacks to both scenarios,” says Mr Stead. “With non-ownership the lender is responsible for the balloon payment so you don’t have to worry about finding the money. But there might be certain restrictions you have to comply with, like a mileage ceiling on the vehicle to ensure the resale value.”
With an ownership option you would be responsible for the payment at the end of the loan, although ownership of the vehicle will be transferred to you. “It is possible to refinance the car, and pay the balloon payment off over a longer period, or you can sell the car,” says Mr Stead. “In some instances, the value of the car can be less than the residual owing, meaning that even if you sell the car, you’ll still owe money to your lender.”
In both scenarios, you will be required to have insurance so that if anything were to happen to the vehicle, you or the lender would be covered.
Buy a car the right way for you
“People have different priorities when purchasing vehicles,” says Mr Stead. “Some want to pay them off as quickly as possible, and then own the car. Others want to keep driving the newest model of their vehicle. For those folks, finance with a residual payment is an option, but it’s worth remembering that if you keep buying a car on residual, you are allocating a portion of your income to your car indefinitely.”
Mr Stead says a residual payment is not a good idea if you’re trying to save money.
“Residual payments can cost you more in the long term, and if you’re short of cash, you’re probably not going to have the funds at the end of the loan term. Rather try to buy a cheaper vehicle with monthly payments that you can afford.”