A balloon payment, sometimes called a residual, is a lump sum due at the end of an equipment finance agreement. In exchange for deferring part of the amount owing, your regular repayments are lower. It is a legitimate tool, and used well it can match cash flow to the way an asset earns. Used carelessly, it just moves a problem four or five years down the road.
How it works
Say you finance a machine and agree a term of five years with a balloon of 30% of the original amount. The lender calculates your monthly repayments as if you were paying off only the other 70%, plus interest on the whole balance as it falls. At the end of the term you still owe the balloon. You can pay it from cash, refinance it, or, in some structures, sell the asset and use the proceeds.
Here is an illustrative example only. It uses 8.5% per year with no fees, so a real comparison rate would be higher:
| No balloon | 30% balloon | |
|---|---|---|
| Amount financed | $50,000 | $50,000 |
| Term | 5 years | 5 years |
| Approx. monthly repayment | $1,026 | $824 |
| Balloon due at end | $0 | $15,000 |
| Approx. total interest | $11,540 | $14,450 |
The balloon version saves around $200 a month. It also costs roughly $2,900 more in interest and leaves the $15,000 to deal with.
When a balloon can make sense
- The asset holds its value. Trucks, some construction plant and well-maintained vehicles often retain a good portion of their price. A balloon set at a realistic resale value means you could sell and settle.
- You plan to upgrade. If you expect to swap the item in a few years, a balloon lets you keep repayments low and trade up when the term ends.
- Seasonal or growing income. Lower repayments now, with a plan to be stronger later, can be a sensible bet, as long as it is a plan and not a hope.
When it can bite
- The asset loses value faster than expected, so it sells for less than the balloon.
- Interest rates rise before you need to refinance, or lending criteria tighten.
- The business has changed, and the lump sum is simply not available.
- You underestimate wear. Hours, kilometres and condition all affect resale.
The lender is not responsible if the equipment sells for less than you owe. The shortfall is yours.
Sizing a balloon sensibly
There are no universal rules, and lenders set their own maximums based on the asset and term. A cautious approach is to ask what a used example of the same asset, at the age it will be when the term ends, typically sells for. Then choose a balloon comfortably below that figure. Browsing similar used listings gives a real-world sense of values.
Planning for the end date
If you take a balloon, treat it like a bill you already have. Some owners set aside a small amount monthly in a separate account. Others plan to refinance the balloon into a new agreement. Whichever you choose, start thinking about it at least a year ahead, because lenders will want to review the business again at refinance time, and approval is never guaranteed.
Tax considerations
How a balloon is treated for tax depends on the structure and your circumstances. The Australian Taxation Office publishes information on depreciation and business deductions, and your accountant can tell you how it plays out for you. Do not assume a balloon is treated the same way under a chattel mortgage and a lease. Our chattel mortgage vs lease guide covers the differences at a high level.
Questions to ask the lender
- What is the balloon amount in dollars, and when is it due?
- What are my options at the end: pay, refinance, sell, return?
- Is there a fee to refinance or extend?
- What does the total cost look like with and without the balloon?
Takeaway
A balloon is a trade-off between today's cash flow and tomorrow's obligation. Look at the total cost and have a written plan for the end of the term. This article is general information and not advice. Figures are examples only; actual rates, fees and eligibility vary by lender.
