Balloon Payment

A `balloon payment` is a large payment that is normally made at the end of a finance agreement.

It is also referred to as a lump sum and is a portion of the capital cost/value of the vehicle that the customer is not paying for within the regular payments that they make to the finance company.

A balloon payment benefits the customer because by deferring payment of a lump sum to the end of the agreement, the customer can enjoy lower monthly payments or a shorter term.

Finance repayment cycle:

Deposit
Fees
Regular Payments
Balloon Payment

Contractual Requirements

A balloon payment can be optional or mandatory depending on the terms of the finance agreement. The amount of the balloon is usually calculated based on the estimated value of the vehicle on disposal (when the finance agreement ends).

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Balloon Calculation

It is important for finance companies to be conservative when determining the actual value/amount of the balloon. If the value of the vehicle is overestimated then the balloon that is due to be paid will be higher than the actual market value of the vehicle and the customer may be left in negative equity (see Glossary).

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Balloon Implications

The balloon also attracts interest from the lender and because the amount is not being repaid by the customer until the very end of the finance agreement, the lender may charge a higher overall rate of interest to compensate for the higher risk they are exposed to in providing this facility.

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Guaranteed Minimum Future Value

A Guaranteed Minimum Future Value (GMFV) – see Personal Contract Purchase module – is a balloon payment that is guaranteed by a third party – normally a finance company or vehicle manufacturer. This means that the balloon amount is fixed.

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