What Is A Balloon Payment?
A balloon payment is the final lump sum you will be required to pay if you want to own the car after your PCP (Personal Contract Purchase) finance agreement. It is often referred to as the ‘Optional Final Payment’.
Want to find out more about balloon payments and their significance in car finance? Read our handy guide to find out everything you need to know about these end-of-contract payments.
What is an example of a balloon payment?
The balloon payment will be a lump sum fixed on to the end of your contract. So, for example, a £20,000 car may only be worth £8,000 by the end of your three-year agreement. In this case you would make monthly payments over the term and at the end of the three years, you have the option to buy the car outright for the £8,000 balloon payment.
Do I have to pay the balloon payment?
No, you don’t have to pay the balloon payment.
At the end of a PCP car finance deal you have three options:
- Pay the balloon payment and become the owner of the car
- Start a new finance agreement on the same car*, or get a brand new one.
- Hand the car back and simply walk away
*This option is called ‘refinancing’ and is suitable when you can’t afford the balloon payment, but still want to own the car.
If you want to buy the car outright, you will have to pay the balloon payment. This can be done in one go or there is the possibility of spreading this payment over time as well. The latter is what you’ll do when you choose to refinance the balloon payment – splitting the lump sum into monthly payments that then allow you to pay off the car and own it.
How is a balloon payment calculated?
The value of the balloon payment is based on the expected depreciation of your car.
Prior to your agreement, the dealer will predict what the resale value of your car will be after your deal has ended. This will be the GMFV (Guaranteed Minimum Future Value) and therefore the sum you would have to pay if you wanted to purchase the car outright after you have paid the loan amount off.
The dealer uses a number of things to calculate the GMFV:
- Make and model of the car
- Your expected annual mileage
- Length of the agreement
- Any other factors that would contribute to depreciation
How will a balloon payment affect my PCP monthly payments?
The balloon payment value will actually make your monthly payments much cheaper.
Because it is a set figure that you will have to pay after the agreement has ended, it won’t be included in the monthly payments.
So using our earlier example, if a £20,000 car has an £8,000 GMFV and a £2,000 deposit – you are only loaning the remaining £10,000 from the finance provider. So instead of splitting the full £18,000 (full value minus the deposit) between the monthly payments, you are only splitting £10,000, and potentially paying the £8,000 after.
Will the balloon payment ever increase or decrease?
The actual balloon payment will never change. It is set by the dealer so that you can pay off the value of the car’s depreciation until it hits that GMFV.
What will likely change though is the car’s actual value. Sometime’s the dealer gets their prediction wrong and the value of the car will differ from the GMFV. That will never cause you any problems however. If the car is worth less than the pre-agreed figure, you will not be charged any additional fees – provided you have kept the car in good condition as specified on your contract.
If the value of the car is actually higher than the pre-agreed GMFV then you will still be able to buy the car for the amount previously agreed.
If you decide not to buy it, you will have something called positive equity, you can put this towards the deposit on a new PCP car finance deal. You can’t however swap it for cash.
Does interest take the balloon payment into account?
When you take out a PCP deal, you will pay interest on the loan. This is essentially the cost of taking out the loan.
With a PCP agreement however, both the loaned amount, and the balloon payment will be included in the interest charge. So going back to our £20,000 example, you will be charged interest on the full £18,000, as opposed to just the £10,000 you are actually loaning.
This will of course make the interest payments slightly higher, so it is always worth working out the total costs over the length of your contract to work out the best deal.
Can I refinance the balloon payment?
Yes, you can refinance the final balloon payment.
If the GMFV is quite high and therefore paying the final balloon payment is out of reach, you can choose to refinance the payment. You can choose to do this as another PCP, or a Hire Purchase (HP).
Another PCP will mean putting down another deposit, more monthly payments, and include another balloon payment at the end. Albeit these will all be considerably less than the amounts from your first contract.
With a HP deal you pay the full remaining value of the car off in monthly payments, with no final balloon payment. For more information about Hire Purchase deals, check out our other comparison guides.
Want to find out more about car finance and leasing? Check out our guides page to find out everything you need to know.