Balloon Payments on Equipment Finance: Pros, Cons and Costs
Quick answer: A balloon payment is a lump sum due at the end of a finance term. It can lower your regular repayments, but you still owe the balloon, and it usually adds to the total interest you pay. Whether it suits you depends on your cash flow and plans for the asset.
General information only. Lender criteria and products vary.
What is a balloon payment?
With some equipment finance agreements, such as a chattel mortgage, part of the amount borrowed is not repaid through the regular instalments. That remaining amount, the balloon (sometimes called a residual), is due at the end of the term.
Because you repay less of the loan during the term, regular repayments are usually lower than they would be without a balloon.
What can you do at the end?
Options depend on the agreement and the lender. Common choices include:
paying the balloon from your own funds
refinancing the balloon into a new loan
selling the asset and using the proceeds
trading in the asset, where the supplier offers it
Plan which one you are likely to use from the start. Do not assume the asset will be worth more than the balloon.
Advantages
Lower regular repayments can ease cash flow.
It can match the way an asset loses value over time.
It may suit a business that plans to upgrade equipment regularly.
Disadvantages
You still owe the balloon, which is a real obligation.
Interest is charged on the unpaid balance for the whole term, so the total cost is generally higher than without one.
If the asset is worth less than the balloon at the end, you may need to make up the difference.
Refinancing the balloon depends on the lending criteria at the time.
Example
A landscaping business finances a $90,000 excavator over five years. With no balloon, the whole amount is repaid through instalments. With a balloon, a portion is left to pay at the end, so each instalment is lower, but a lump sum is due in year five. The right choice depends on the business's cash flow, how long it will keep the excavator and its expected value.
This example uses round numbers for illustration only. It does not show a rate or an actual repayment.
How a balloon compares with other structures
No balloon. The whole amount is repaid over the term, so repayments are higher but nothing is left to pay at the end. This gives certainty about the final cost.
Balloon (residual) on a chattel mortgage. You own the asset from the start, repayments are lower, and a lump sum falls due at the end. This is common for vehicles and machinery that hold value.
Hire purchase. You pay the asset off over the term and ownership generally passes to you after the final payment. Some agreements include a final amount similar to a balloon.
Finance lease. The lender owns the asset and you pay to use it. End-of-term options, including any residual, depend on the agreement.
The label on the product matters less than the terms. Ask the lender or your broker to show the repayments, the final amount and the total cost side by side for each structure you are considering, so you compare like with like. The finance calculator can give you a rough starting point.
Planning for the lump sum
If you take a balloon, treat the final payment as a bill you already know is coming:
Set aside money regularly, or work out what you will refinance.
Check the likely value of the asset against the balloon. Equipment that wears quickly or has a narrow resale market carries more risk.
Think about how your business might look in three to five years. A growing business may want to upgrade before the term ends, while a stable one may keep the asset for its whole life.
Keep the maintenance and condition of the asset up. It affects what it is worth at the end.
A balloon is not good or bad on its own. It is a trade between a lower payment now and a larger obligation later.
Who a balloon may suit, and who it may not
A balloon may suit a business that expects to upgrade the asset before the term ends, has seasonal or growing cash flow, or knows it will have funds or a plan for the lump sum. It may be a poor fit for a business that wants certainty about the final cost, plans to keep the asset long term with little spare cash, or owns an asset that loses value quickly or is hard to resell.
Ask whether the repayment saving is worth the extra interest you are likely to pay over the life of the loan. A lower repayment feels easier today. The balloon is the price of that ease, and it is still owed.
Questions to ask before choosing
What is the total cost over the term, including interest and fees?
How big is the balloon, and how will I pay it?
What happens if I want to pay the loan out early?
How will the structure be treated for tax and GST? Ask your accountant.
Do the repayments suit seasonal cash flow?
Frequently asked questions
Is a balloon payment tax deductible?
Generally, a balloon repays part of the amount financed and is not automatically a separate deduction. Check the treatment with your accountant.
Can I have a balloon on a used asset?
Possibly. Lenders look at the age, condition and value of the asset, and criteria vary.
Do all equipment loans allow a balloon?
No. Some products and lenders do not, and the size allowed varies.
Will a balloon make approval easier?
Not necessarily. The lender still assesses your ability to repay both the instalments and the balloon.
Is a lower repayment always better?
No. Compare the full cost and the end-of-term obligations, not only the repayment.
Want to compare structures?
Use the finance calculator for a rough view, read Equipment Finance vs Chattel Mortgage, or explore Equipment Finance. Tattersalls Finance can compare options from a broad panel of lenders at no cost to you. Contact us to talk it through.
General information only. Not financial, credit or tax advice. Lender criteria, fees and approvals vary and are subject to credit assessment.
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