The financial services sector may be seen as having a language all its own, at least to some extent. The terminology and abbreviations used by lenders and finance brokers can leave some business customers flummoxed. Sourcing commercial loans is not a process that all business operators undertake on a regular basis. So fully understanding every detail of loan products is simply not a priority, until you need to apply. Adding to any potential confusion is the range of different commercial finance products available, each with varying names for seemingly the same concept.
A balloon is one such term that raises questions. We’re providing this explainer to clarify what a balloon is, how it applies in business loans and how you can utilise a balloon to structure your loans to suit your cash flow and repayment expectations.
Explaining Balloon Payment
The term balloon relates to Chattel Mortgage and Commercial Hire Purchase finance facilities. With Leasing, essentially the same concept is called the residual. As these types of finance are for asset acquisitions, the balloon/residual can apply to finance for business car loans, truck finance, equipment loans. Selecting to include a balloon in a finance contract is purely optional, it is not compulsory.
The balloon/residual is an amount of the loan which borrowers can choose to defer for payment at the end of the finance term. It is usually represented as a percentage. It is a percentage of the loan before interest on the loan is added. That means, if you choose no deposit finance, the balloon would be a percentage of the purchase price of the goods being financed.
The balloon is due for payment in full after the final repayment is made. Only when all repayments and the balloon have been finalised does the lender withdraw the security over the asset subject to the finance.
Utilising the Balloon
When a balloon is included in a Chattel Mortgage or CHP, it reduces the amount of the monthly repayments with the balloon payable at the end of the finance term. The larger the balloon the smaller the monthly loan repayments but more is due at the end. While the smaller the balloon the larger the repayments and the less due at the end, over the same loan term.
Interest is charged on the balloon at the rate established for the overall loan.
Business utilise a balloon to set aside a portion of the cost of equipment and vehicles to a later time and thus be able to agree on a repayment amount that meets their cash flow and budget requirements. Some lenders will have guidelines around how large a balloon they will agree to when approving a finance application.
Deciding how much the balloon should be is a decision for the borrower. If using an unsecured or secured business finance broker, they will explain the variations and scenarios but it is up to the business owner. As a general guide, businesses would typically not want the balloon payable at the end of the loan to exceed the perceived value of the car, truck, or equipment.
Calculating Balloon Scenarios
An easy and graphic way to see how balloons work is to use our loan calculator. Enter the amount you want for your loan in total (don’t deduct the balloon), the finance term you are seeking on your commercial loan, and a balloon amount. You will see a repayment estimate.
Now, leave all data the same but change the balloon amount. You’ll immediately see how the repayment estimate changes, up or down.
When planning how you would like your finance contract structured, prior to briefing your broker or approaching a lender, you can use an online business loan repayment calculator to establish the balloon amount.
Paying out the Balloon
The balloon is payable in full after the last monthly repayment is made. Borrowers have a few ways in which they can choose to finance the balloon.
- Any balloon would need to be finalised before a sale of the equipment could settle. If choosing to sell the equipment with a balloon owing the balloon could be paid out with the proceeds of the sale.
- A balloon can be paid by a business’ existing funds/cash.
- If trading in a car with the balloon owing, the motor vehicle will often liaise with the lender to pay out the existing finance/balloon with the trade-in price. Any excess could be applied as a deposit on the new vehicle.
- If retaining the equipment when the balloon falls due, businesses can seek to refinance the balloon. This would involve taking out a new loan for that amount. The new loan can be with another Chattel Mortgage or CHP or Leasing, subject to lender guidelines of course. If the balloon falls below the minimum threshold for asset acquisition for most lenders, Business Finance may source you a secured or unsecured business loan.
Including a balloon in a Chattel Mortgage or CHP finance deal is a very common practice and it can be a useful strategy for achieving the repayment level desired by the business.
Contact 1300 000 033 to discuss your lending requirements.
DISCLAIMER: THE SPECIFIC PURPOSE IN PROVIDING THIS ARTICLE IS FOR GENERAL INFORMATION ONLY. IT IS NOT INTENDED AS THE SOLE SOURCE OF FINANCIAL INFORMATION ON WHICH TO MAKE FINANCIAL DECISIONS. THOSE THAT CONSIDER THEY REQUIRE ADVICE OR GUIDANCE AROUND THEIR SPECIFIC FINANCIAL CIRCUMSTANCES ARE RECOMMENDED TO CONSULT WITH A FINANCIAL ADVISOR. NO LIABILITY IS ACCEPTED IN REGARD TO ANY MISREPRESENTATIONS OR ANY ERRORS RE ANY DATA, SPECIFICS, POLICIES AND OTHER INFORMATION AS SOURCED FROM OTHERS.