The Balloon Payment (or Residual) is the final payment needed to finalise an equipment or motor vehicle finance contract.
Business owners and individuals often prefer to include a Balloon Payment in their finance contract to reduce their monthly repayments.
- Balloon Payments bear interest but are not amortised over the term of the facility
- They approximate the value of the asset at the end of the contract – this being set by the ATO
- Repayments are based on the financed amount less the Balloon Payment
At the end of the finance contract, you have a number of options available. The one you choose will depend on what you intend to do with the asset.
The key is to plan and understand the implications of each alternative.
Balloon Payments – Key Questions
Before looking at options regarding the Balloon Payment, the first decision needed is whether you want to keep the asset, sell it, or alternately upgrade?
Many factors will influence this decision like:
- It’s useful life
- The degree to which the equipment or vehicle will start to incur higher repair or maintenance costs if retained
- The cost of upgrading
- Whether newer models will deliver higher productivity gains and/or lower costs
- How the cost of refinancing the Balloon Payment compares with an upgrade
- Depreciation write-offs associated with new equipment/vehicles
Balloon Payment – Sell the Equipment or Motor Vehicle
If the Equipment or Motor Vehicle is surplus to your needs, you may decide to repay the Balloon and then sell the asset to reimburse your cash flow.
(If you sell the asset for more than the outstanding amount, any surplus you retain is profit).
You may also decide to sell and then use the funds from the sale as a deposit on new equipment or motor vehicle.
(Depending on the asset, this may be better than using it as a trade-in)
Retain the Equipment or Motor Vehicle
Should you decide to retain the equipment or motor vehicle there are two options available in relation to the Balloon Payment:
- Pay the Balloon Payment in full. This option is very straight forward and suits borrowers who want to retain the asset, with no ongoing financial commitment. Once the Balloon is paid, the Lender will then discharge their interest and you can do what you like with the asset. Whilst straight forward, the downside is, it may use cash that could be used for better purposes in the business
- Refinance the Balloon Payment by taking out a new loan. The length of the loan will vary depending on the type and age of the asset being refinanced. The upside is, as you are only refinancing the Balloon, your repayments will be lower. The downside will be the interest rate may be higher than for new equipment. (For some equipment a valuation may also be required)
If you are looking to refinance the Balloon Payment, it is important to have everything set up before your current facility expires. I can help you here – simply get in touch.
Upgrade the Equipment or Motor Vehicle
If you decide the cost of acquiring new equipment, or motor vehicle outweigh retention, then to improve your negotiation power, seek approval of finance before approaching suppliers.
Depending on the equipment, you may be able to trade in the existing asset to reduce the amount borrowed. But as stated above, you may find it better to sell the asset and use these funds as a deposit.
When seeking finance, it is important to:
- Focus on the total cost of the finance over the term – not the headline interest rate
- Structure the repayments to suit your cash flow
- Choose the right structure and product so that ownership and tax benefits are maximised
Summary
As outlined, there are options available to deal with the Balloon Payment due at the end of the contract.
Which is best will be determined by your circumstances.
If you would like to learn more or obtain a quote for equipment or motor vehicle finance, don’t hesitate to give me a call.
