Residual value or a balloon payment explained

Posted on Friday, September 18, 2015 - 14:57

The residual value is a term that has been used in the Lease Agreements and it makes reference to the value a fixed asset has when its term has finished. So, if you will take a loan for a car for 5 years, the residual value will be the value it still has after those 5 years have passed.  

This residual value is usually established by the financial institution that offers the loan or the lease. The value is determined prior to the start-off of the lending process and it is set up according to forecasts and previous models. Along with the interest rate and the tax, the residual value is also crucial when establishing the monthly payments that are going to be made.

The residual value is going to reduce the monthly instalments which are also known as rentals. The lease agreement will allow the residual value to be paid, just as the last payment has been done.

What is the balloon payment?

The balloon payment, on the other hand, is a term that has been used in some different financial structures such as the consumer loan, commercial hire purchase or the chattel mortgage.

The concept is similar to the residual value, in the sense that it represents the amount of money that has remained and that has resulted from the purchase of a vehicle as a last payment that has been made at the end of the term of the car finance. The greatest difference between the two concepts is, however, the flexibility that characterizes the balloon amount.

Now, in terms of differences, unlike the residual value, the balloon payment is not based upon forecasts that would indicate the depreciating value of the vehicle in time. This gives the buyer the possibility to choose the size of the balloon payment, depending on the subject to the finance approval and the finance term. There is also the possibility of not having a balloon payment at all, as it is not a mandatory request.

Balloon payment – Benefits

The greatest benefit a balloon payment brings by is the fact that it reduces the monthly instalment. The borrower also has the ability of having a wider flexibility in what concerns the refinancing of the balloon by paying it with cash or by trading in the car and refinancing the balloon by using the trade value.

If the vehicle is being used mostly for business purpose, then having a balloon would increase the amount of interest that is payable over the complete term of the car loan. As a result, you will be paying less principal – which is not deductible – with every single repayment you make by having the balloon offset at the end of the transactions.

If the vehicle is used for personal purposes, it would only result in paying much more interest in general, with the main benefit of reducing the monthly repayments.

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