Addressing the Balloon in the Room
With the South African middle class rapidly expanding, banks and loan companies have been shelling out the loans to help people keep up with the Jones’.
In particular, South Africans enjoy having nice cars, often cars they cannot afford. And this is where the loan sharks start circling in. If you desperately want a new car, but can’t afford the monthly instalments, fear not, the suave, honey-tongued man at the car dealership is going to offer you a golden ticket.
The Balloon Payment
Briefly put, a balloon payment (or residual) is where the lender cuts off a chunk of the total cost of the car (about 30 %) and leaves it out until the very end. This results in you paying a manageable instalment each month. But when that final instalment is due in 5 or 6 years, you will also be obliged to pay the secret sum you forgot about. The balloon in the room, that 30 % you forgot about (plus interest).
Remember that your friendly, charismatic car dealer is only holding that sparkly gaze with you because he really wants to sell that car. Even if it is way out of your budget, the manager can re-calculate your monthly instalments to a manageable number and throw the remaining expenses into that final payment due at the end of the agreed-upon payment schedule. The positives with this scheme are:
1. You can afford more expensive assets by paying smaller instalments each month, without taking 100 years to pay them off.
2. If your financial position is stable or improves over the period of the payment scheme, then the residual will not be an amount that will cripple you to pay.
The negatives are:
1. Customers are not sufficiently informed by sellers that the lower instalments are accompanied by an extra final instalment. This is very important. When you sign a contract to pay for something like a car, the seller will often not mention the balloon at all. If they do, they quickly mumble over it before handing you the pen for your ‘million dollars’.
2. If your financial position over the payment period worsens, then the residual will be likely impossible to pay in one go and you will then be dragged into paying further instalments.
3. You will probably not take the balloon payment into account when planning your annual budget.
4. The longer payment scheme will lengthen the time it takes for the money-owed on an asset to be equal to the value for which it can be traded. i.e. the bank gets to milk all that inflated interest out of you, while you pour money into fuelling, maintaining, insuring and fixing that car.
I am not saying that balloon payment schedules in themselves are the work of the devil. If a customer knowingly enters into the contract and saves appropriately, the car is theirs in the 5 or 6 years it takes to pay it off. The problem is that this payment structure is not targeted at those fastidious individuals who inspect each page of their contracts with a magnifying glass. It is targeted at those in the middle-income bracket, people who have nearly enough money to buy all the shiny things they want, don’t have the patience to save and have zero interest in reading contracts. Future Me can worry about being broke because right now, I’m cruising in my brand new BMW X5.
One of the legal responsibilities of sellers is that they need to make you read the contract and understand it, or at least guide your pen to the dotted line while distracting you with the various climate control options on offer. Contracts are boring, no one wants to read them. That’s because we know they contain horrible statements in them, that we knowingly ignore to our immediate satisfaction and later on, detriment.
You have been warned, but if you insist on going ahead with that purchase make sure to:
1. Take photos or make copies of ALL documents you sign or you correspond with.
2. Discuss the niggly bits of your payment scheme and contract with your dealer AND the bank.