What is a balloon or residual payment?
A balloon payment can be applied to any Truck Finance or Heavy Equipment Loan facility in order to reduce monthly payments and preserve cash for working capital purposes. A balloon payment might also be called a residual or RV depending on what type of loan is in place. If the loan type is a chattel mortgage the payment is referred to as a balloon payment, but if the loan type is a lease the remaining payment is referred to as a residual payment or RV payment.
To qualify for a balloon or residual payment the goods have to be no older than 5 years at the time of purchase. Ideally the balloon or residual payment should represent what the value of the equipment will be worth at the end of the term.
Example of how a balloon payment can reduce monthly payments
With Balloon Payment
New truck purchased – $350,000
Term of the loan – 5 years
Loan Type – Chattel Mortgage
Balloon – 30% or $105,000
Monthly Payments – $5,100 per month
No Balloon Payment
New truck purchased – $350,000
Term of the loan – 5 years
Loan Type – Chattel Mortgage
Balloon – NIL
Monthly Payments – $6,600 per month
In the above example, by applying a 30% balloon, monthly payments are reduced by $1,500 per month. The reduced payment is achieved as payments are only made on a loan amount of $245,000 as opposed $350,000 ($350,000 purchase price less $105,000 balloon payment).
The balloon value that is applied to the loan contract, should represent what the approx. value of the truck or equipment will be at the end of the term. If the truck will not be doing many km’s over the life of the loan, the balloon payment could be increased to 40% of which would further reduce the monthly payments.
What happens to the balloon or residual payment at the end of the loan term?
If a balloon or residual payment has been applied to the loan contract, a one off payment is due to be paid at the end of the term in order to finalise the contract.
This can be done via the following scenarios;
- The balloon payment can be refinanced – client keeps the truck or equipment and refinances the balloon payment over a nominated term.
- The balloon payment can be paid in full – client retains ownership of the equipment by making payment with own funds to payout the balloon to finalise the contract.
- The balloon payment can be paid out if client trades in current truck – client upgrades to a newer truck and trades in the existing truck at a dealer. What the dealer offers for a trade on the existing truck should be sufficient to payout the balloon payment.
What are the benefits of having a balloon or residual payment for Equipment Finance?
- Reduces monthly payments so that client can preserve cash for working capital
- Gives client option of keeping the goods at end of the term by either refinancing the balloon or paying it out in full
- Gives client option of trading equipment and upgrading to newer equipment
- Can help achieve a finance approval if the servicing position of the client is border line (as the total financial commitments are lower)
- Balloons can be applied to all types of equipment such as Farm Machinery Finance and all other Heavy Equipment Finance facilities
What are the benefits of not having a balloon or residual payment for Equipment Finance?
- At the end of the term the goods are owned outright by client
- Builds equity into the equipment quicker than if a balloon was applied
- Makes it easier to trade in a truck or equipment before the end of the term
Residual or RV payments on a finance lease or operating lease
The discussion in this article so far, has been focused on chattel mortgage loans and balloon payments. If the loan has been structured as a lease or an operating lease, the end of term payment is a residual payment. Leases operate a bit differently than a chattel mortgage, as the finance company owns the goods with client renting it back for a pre-determined period of time.
Operating Lease – If the loan is an operating lease, no residual payment is required to be paid by the client, as the residual risk is held by the finance company. As this is the case, client makes rental payments on the loan for the five years and can simply hand the goods back with no additional payment. Or alternatively, client can purchase the goods back from the finance company at fair market value.
Finance Lease – If the loan is a finance lease, a residual payment has to be applied to the facility. The residual value assigned to the loan contract is based on ATO guidelines relating to the specific asset being purchased.
In summarising features of Balloon or Residual Payments
- A balloon payment reduces monthly payments as the actual loan amount is reduced by the value of the balloon payment
- Allows the client to preserve cash flow for working capital purposes
- The balloon payment can be refinanced by client at the end of the term
- Client can payout the balloon in full and own goods outright
- Client can upgrade existing machine for a new one by trading in current machine (what the dealer offers for the trade should equal what the balloon payout is)
- Balloon payment is optional for Chattel Mortgage Loans
- Residual payments on a finance lease is set by ATO guidelines
- No residual payments apply to operating leases, which removes any resale risk for the client
- Balloon payments can only be applied on new purchases or goods up to 5 years old at time of purchase
- Balloon payments need to be set so that the value is commensurate with what the goods will be worth at the end of the term
