How Will A Balloon Payment Affect My Credit?

Financing a major purchase usually comes with several options. If you’re on a tight budget, low monthly payments are appealing and necessary. Many people choose balloon payment financing with this goal in mind, opting for lower immediate payment and a final, large payment at the end of the term. Mortgages and auto loans are common vehicles for balloon financing. Consider the following pros and cons before making a decision. They will help you choose the right path with credit health in mind.

Pros

• Greater monthly savings. A lower monthly payment means greater savings, allowing you to focus on retirement planning, debt reduction and other financial priorities. As long as your purchase doesn’t increase your credit utilization ratio to 30 percent or more, opting for balloon financing could actually help your credit repair efforts.
• Lower interest rates. A catalyst of credit damage is high interest rates. A compounding principal balance makes it difficult to manage and effectively reduce long-term debt. When it comes to auto financing, the average balloon option offers a lease-like term with no interest unless you choose to refinance the final payment. Balloon mortgages usually provide lower interest rates and closing costs than their fixed mortgage counterparts. In both situations, you’ll owe less interest on the principal balance by making the final balloon payment at the end of your agreement.
• Sales options. Suppose you plan to move to a major city within the next five years. You need a car now but don’t want to invest too much money. Balloon payment financing allows you to make low monthly payments and sell the car before the final balance is due. If a sale is on the horizon, balloon payment financing could put money back in your pocket. Review the agreement terms when considering this perk.

Cons

• Planning for the final payment. Balloon payment financing is great for those who want to limit long-term debt by paying it off in a shorter amount of time. On the other hand, accomplishing this task requires hefty planning. For example:

Chris recently leased a 2016 Mercedes GLA for $350 per month. The lease term is 36 months, and Chris plans to buy the car at the end of the term with a final balloon payment. He is confident that a work promotion will allow him to afford the remaining $20,000 balance. Unfortunately, Chris’s career derails after three years, and he cannot afford to write a check for his Mercedes. He must either return the car and lose his invested cash or apply for financing.

• Need for refinancing. If your planning doesn’t match the bottom line payment, what is the alternative? As Chris learned, many people choose to refinance the remaining portion of their loan in lieu of writing a check. This decision is problematic because:
  • Your interest rate may increase to match current market trends
  • Your monthly payment is likely to increase as the new interest rate and loan terms are applied
  • Refinancing could affect your credit utilization ratio and the diversity of accounts on your credit report
  • The plan to save money and reduce debt is sidelined
• Risk of foreclosure or repossession. Although the payment terms of balloon financing are clearly spelled out, the risk of default is still higher than traditional financing options. As we’ve learned, the x factor is planning. Sure, you might opt to refinance your remaining balance, but what if your credit is denied? In addition to property foreclosure or car repossession, your credit score will suffer the consequences of a bad deal for up to seven years.

The bottom line: Predictability and credit health go hand in hand. With careful planning, financing a home or car with a balloon attached can enhance your credit file and improve your score. Poor planning will accomplish the opposite. Choose your course wisely.