A “balloon” is a lump sum payment that can be structured at the end of term of a car or equipment finance contract, normally for the purpose of reducing repayments.
Customers often have the option of structuring their loan to either completely pay off the loan over the term or could choose to have a lump sum payment at the end.
However Balloon payments are not a “once size fits all approach”. There can be various benefits to a balloon, but they are not for everyone:
✅ When to structure a Balloon on a car or equipment loan:
- When Cash Flow Management Is a Priority
Including a balloon value can help clients manage their cash flow more effectively, as it reduces the monthly repayments over the term of the agreement. If a client is looking to maintain liquidity and is confident they can manage or refinance the lump sum payment at the end of the term, a balloon payment can be a great option. - When the Asset has a known future value
If the future value of the asset can be estimated reasonably accurately (such as cars, earthmoving equipment), structuring the balloon to match the future value can avoid tying up equity in depreciation assets. This equity or cash flow can then be used in other parts of the business that can provide a better return on investment. - Multiple options at end of term
If there is a lump sum at the end of term, and the balloon was structured correctly, a customer has multiple options at the end of term. They can simply sell the asset and payout the loan, or if they intend to keep the asset, they can either pay the balloon out in full, or in most cases have the option of refinancing over an extended term. - Tax Benefits and Accounting Treatment
A Balloon/lump sum payment at the end of the contract may result in higher interest costs, however in most cases the interest is tax deductible. Many businesses are prepared to pay slightly higher interest costs as this is tax deductible, as a trade off for reducing repayments and easing cash flow pressure
❌ When Not to structure a Balloon on a finance contract:
- When There Is Uncertainty About Asset Value at End of Term
If the future value of the asset is difficult to predict, including a balloon may pose a risk to your client. For instance, some assets may have unpredictable depreciation rates, or they may not have a strong resale market. This could result in a shortfall between the actual value of the asset at the end of the term and the agreed-upon balloon (known as Negative Equity). - When There Is a Desire for Full Ownership Without Complications
If your client is focused on full ownership at the end of the term and prefers to pay for the asset over the life of the finance arrangement without any large outstanding payment, it might be best to avoid a balloon. - When the Asset Is Likely to Have Little Value at End of Term
For assets that are highly specialised or are expected to have very low resale value (e.g., custom machinery or highly specialised equipment), a balloon might not make sense. The client could be left with an asset that is difficult to sell or of little value, making the balloon payment unnecessary or burdensome. - When the Client Is Risk-Averse
Some clients prefer to avoid the uncertainty and potential risk associated with balloons. For these clients, the desire for financial certainty and predictable cash flows may outweigh the benefits of lower monthly payments, making a straightforward financing arrangement without a balloon the better choice.
As accountants, your expertise in evaluating financial risks and cash flow strategies is crucial in advising clients on asset finance options. By carefully considering these factors, you can help your clients make an informed decision about whether a balloon is the right choice for their asset financing needs.
Equipfin specialises in Car & Equipment finance loans and works closely with accounting firms to provide accounting firms and their clients with support and guidance to structure finance contracts suited to the clients individual situation.
If you or your clients need assistance with car or equipment financing, we are here to help.
