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Balloon Payments and Residual Values Explained

When instant gratification competes with good reason!

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What happens when the balloon payment / residual value is due?

There are generally a two options available when the Residual Value/Balloon Payment on a loan falls due:
The Residual Value/Balloon Payment can either be paid in cash or, the borrower can refinance or ‘roll over’ their Residual Value/Balloon Payment into a new loan. Rolling over the balloon payment is usually subject to approval by the bank. Take note that refinancing the car could mean that you will be paying this car off over a longer period than you will likely want to be driving it.
The vehicle can also be sold and the proceeds are then used to pay the Residual Value/Balloon Payment and finalise the loan. If you negotiated the loan at the maximum allowed residual value, the sales price would almost exactly match the amount required to settle the outstanding lump sum.

How big can the residual amount be?

The maximum Residual Value/Balloon Payment, varies depending upon a range of factors specific to each financial institution, but generally includes the age of the vehicle, the loan term, and the borrower’s financial profile.
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’, formerly known as the Mead & McGrouther Auto Dealers’ Guide, to predict what a specific vehicle would be worth at the end of a determined period of time.
For example: A car is valued at R100,000 and it is predicted that the vehicle would be worth R60,000 after 3 years and only R40,000 after 6 years. The vehicle will thus only retain 60% of its value after 3 years and only 40% of its value after 6 years. In this example, no financial institution can grant a balloon payment of bigger than 60% for a 3 year loan and 40% for a 5 year loan, but due to various risks to banks, the actual balloon grant will be even much lower.
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