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Residual Values and Balloon Payments for Loans and Mortgages

If you are looking to get a car, home, or any kind of loan—or already have one—you are likely to have heard these terms thrown around many times: “residual value” this, or “balloon payment” that. The question is, do you know what these mean? How do they differ from each other? And most importantly, do you need them? 

What is a residual value?

In a nutshell, a Residual Value is the forecasted depreciated value of the property at the end of the term. The computation of this residual value is governed by guidelines put in place by the country’s respective Taxation Office. This applies to lease agreements and is mandatory.

Basically, the residual value is the very last payment you make at the end of your lease term. The benefit of this is that your monthly payments throughout the duration of the lease are considerably lower. However, this also means that you will need to pay a hefty sum at the end of the lease. Because of this, many lenders allow you to lease the residual value over an additional term, or even purchase the property outright for the amount of the residual value.

An easy way to look at it is the residual value is how much you can expect to sell the property at the end of its useful life. This is in consideration of factors like depreciation and wear and tear. Not only that, advances in technology also need to be taken into account as, for instance, old models of cars naturally have less value than newer ones.

One thing you must be aware of is the residual value is always dictated by the bank or lender, so it’s not something that you can negotiate. This is based on their projections from past data, as well as projections on customer preferences. You can, however, shop for a loan or lease based on the residual value.

What is a Balloon Payment?

A Balloon Payment is very similar to the residual value in the sense that it decreases the amount of monthly payments throughout the term of the finance agreement, and that there is a sum left over that needs to be paid at the end of the term. However, a balloon payment differs in such a way that it applies to other finance arrangements, such as chattel mortgage in the case of car financing and consumer loans. It also differs in that it is does not necessarily use the forecasted depreciated value of the property. This enables you to select the size of your balloon payment, depending on the terms of your agreement. It is also completely optional, unlike residual value.

An easy way to remember is a balloon payment is basically the payment of a lump sum at the end of the loan. Most loans with a balloon payment attached also run longer than regular loans. In simpler terms, it’s a big loan with an equally big fixed final payment.

Most people go for a balloon payment at the end of the loan as an alternative to a high equity at the beginning of the loan. Much like a large starting equity, this enables the lender to reduce interest and monthly repayments. Furthermore, a lesser known benefit of a balloon payment is that you are less likely to be foreclosed because the lender is aware that they will lose out quite a bit when the property is auctioned off at far less than its original value.

At the end of the loan, some lenders also give you the option to convert your balloon payment into another loan. This comes in very handy for those who have failed to save or raise enough money to cover the large final payment that is expected.

What’s in it for you?

Both residual value and balloon payment have their own distinct advantages and disadvantages. However, both residual value and balloon repayment share the benefit of relatively lower monthly payments. Not only that, you also have the flexibility to refinance the residual value or balloon payment, pay it as a lump sum, or most commonly, in the case of car loans, trade the vehicle in with the aim of having the balloon payment or residual value paid out in the trade.

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