Lease agreements as well as ‘Balloon payment / residual value’ vehicle loans have a lot in common. Both options allow car buyers, on the short term, the opportunity to drive a more expensive car with a payment comparable to a less expensive car.
These two different types of balloon payments are also referred to as ‘ownership’ and ‘non-ownership’ residuals and there are specific benefits and drawbacks to both scenarios:
What is meant by Residual value?
Businesses use the term ‘residual value’ to describe the predicted amount an asset might be worth at the end of its useful life. Similarly, car dealers use the auto industry standard: ‘Trans-Union Auto Dealers’ Guide’, to predict what a specific vehicle would be worth at the end of a determined period of time.
So, instead of spreading the full vehicle price over a normal finance period like four or five years, you defer a percentage, say 30%, of that lump sum to the end of your finance or lease period. This then allows for a much lower monthly instalment during the normal finance period, but you still face the 30% ‘balloon’ payment (residual value) at the end of the loan term / lease period.
In an ownership situation, you are buying / financing the car and are responsible for the lump sum at the end of the loan term, and the ownership of the vehicle will then be transferred to you.
The balloon payment or residual amount can also be refinanced, or another option would be to sell the car.
Non-Ownership residuals (Vehicle Leasing)
With non-ownership or leasing, the bank or financial institution still owns the car at the end of the loan period, and is also responsible for reselling it to cover the balloon payment. In a non-ownership or leasing agreement, you are in effect ‘renting’ the vehicle from the bank.
At the end of a lease term, you don’t have to worry about finding the money to settle the residual amount, but there could be certain restrictions you have to comply with, to ensure the vehicle does not depreciate more than the bank’s predicted resale value. Restrictions could include: Mileage limits usually capped at 15,000 to 25,000 kilometres annually where after a penalty applies and condition limits pertaining to abnormal damage to the car.
Vehicle loans with residual values can be quite complicated. Do proper research and carefully consider which balloon payment, if any, is the wiser choice for you.