Though almost everybody knows how balloon loans work, it is always smart to reexamine the concept so as to have the variables implied fresh to analyze how they work on car loans.
Thus, we will give a short explanation on balloon loans and then, we'll analyze how balloon loans can help you afford a car purchase and in which situations it is advisable to resort to car balloon loans.
Balloon loans explained
A balloon loan is a loan that has monthly payments that are not set up to repay the loan in full when the loan repayment program ends. Instead, when the loan schedule has ended, the borrower has to make a balloon payment which is larger than the rest of the payments and cancels the whole loan's principal so until then, the loan isn't fully paid off.
Balloon loans help keep the monthly payments low as they usually include interests only or maybe a small portion of the balance. Thus, when the final balloon payment is due, the balance of the loan usually equals the loan's principal or is well close to it. This particularity makes balloon loans useful for certain situations or when the purpose is to eventually sell whatever has been bought with the loan's money.
Consequences on Car Loans
Balloon loans are a good alternative when you can't afford the monthly payments on a regular car loan. The affordability of balloon car loans' monthly payments is excellent and lets almost anyone to obtain finance to purchase a car. However, the problem comes when you need to make that balloon payment at the end of the repayment program. If you can't afford it, you'll loose the vehicle and damage your credit.
Why do we say that car loans of the balloon type can be advantageous then? Because, if used correctly, the cost to you can equal almost nothing. If you are one of those who likes to change cars every now and then (i.e. every five years at most), balloon loans can be an excellent tool for you. By using balloon loans you can get a car, use it for five years owning it and paying monthly payments even lower than rent installments.
The idea is quite simple: You purchase a vehicle with a balloon car loan, you use your car for up to 75% of the loan's repayment schedule and then you put it for sale. Hopefully, before the balloon payment is due, you'll have completed the sale and canceled the loan in full. Then, you can take another balloon loan to purchase your new vehicle. It's cheap and viable, the only problem is that you have to make sure that the car is sold before the balloon payment is due or else, you'll have to obtain the money to cancel the loan or refinance it.