What is a balloon payment?
You take out a loan for goods or equipment. Your monthly loan payment is half of what they should because the last payment of the loan is a large portion of the total loan, called a balloon payment.
- You want to buy goods or equipment and loan finance the purchase.
- You are quoted a monthly loan repayment and it seems high to you.
- You are then told the loan repayment can be halved and you can have a balloon payment at the end of the loan.
- So you enter the loan agreement thinking you are getting what you want, at a very low monthly payment.
- Sadly, many buy balloon loan payments like this and set themselves up for a financial nightmare at the end of the loan or lease.
Here is why.
The loan lease they have signed could be as follows. Value of loan $30,000, 36 months, interest and principle payments on $15,000 and one last payment to completion the loan of $15,000.
Assume that you have worked the goods very hard and they are about three quarters through their life span and have been significantly depreciated. You check the market and you can buy your goods for $7,000 in the second hand market.
You have to come up with $15,000 for the last loan payment. Take the situation that you do not have the $15,000 to make the last loan payment. You will be confronted by two options
Option One
What is a value of the goods? $7,000. You do not have the $15,000 so you take out a $15,000 loan to pay for goods of $7,000?
Option two
You sell the goods at $7,000 and take out a loan to pay the $8,000 off the loan Balloon payment. Now you are paying for goods you do not own!
How do you avoid these traps?
If you knew someone who was in this situation how would you rate their ability as a business person. It is amazing how many people get caught up in having to pick option one or option two.
So how do you avoid getting caught? It is quite easy.
Step One
Look at the goods that you want to buy. Now take a same type of goods that were being sold three years ago.
The model may be superseded but try and find out what you would have paid for it then. There is a value in keeping old catalogues.
Step Two
Look at the second hand market for that model of goods. Divide the goods into three categories.
- Light use.
- Medium use.
- Heavy use
How much is each category currently selling for today?
Step Three
Work out what the value the goods have depreciated in the period. If it was sold for $10,000 and is now $5,000 it can be assumed that it will lose its value by 50% in three years.
The numbers may change but the general % value should not. It may be that the value rises in which case there would be a benefit to you.
Step Four
Now look at the goods you want to buy today. Assume that the value of the goods in three years time would be based on past performances.
The price has now fallen in purchasing new goods to $7,000, you then estimate the selling price for them in three years to be $3,500.
Step Five
In the loan lease agreement you pay $7000. You have a balloon loan payment of $3,500. Remember this is the final payment of the loan.
You have much lower loan monthly payment as you are only paying monthly loan payments on the $3500.
At the end of three years you have paid off the $3,500 from your monthly loan repayments, you sell the goods, and pay out the loan balloon last payment of $3,500
Step Six
You now repeat the process and purchase the latest goods by repeating the same process.
You are getting the goods at a lower loan monthly cost than your competitors and you are always maintaining your competitive edge because you are using the latest technology.
This article is a very high level explanation. Be sure that you get the correct investment and taxation advice before proceeding. A Mortgage Broker can introduce you to lenders who can arrange finance for you.
Published: Tuesday 24th August, 2021
