What Is Residual (Balloon) Value When Buying A Car
Found your dream car and now you need to think about financing it? If you’re in the process of buying a car, you may have heard the terms ‘residual value’ or ‘balloon payment’. Not sure exactly what this means? We have broken it down for you.
What Is Residual Value?
When you buy a car you will have the option to finance it with or without a residual or what we usually call a balloon payment. Essentially it is a way to reduce your car payments each month and save a lump sum that you pay at the end. Many car buyers will accept the residual payment as standard, but not every buyer understands the ins and outs of this financing option.
How Does Residual Value Work?
The residual value is the amount of the total value of the car which is deferred or postponed to the end of the contract. This is the estimated future resale value of a vehicle at the end of a leasing contract or finance term. Basically, it’s an estimate of what the value of the car will be after a certain amount of usage, depreciation, and age over a set period.
If you buy a car for R250 000 with a residual of 30% (R75 000), that R75 000, plus interest, is due at the end of the contract term. This leaves you to pay the monthly instalment only on the R175 000 (R250 000 less the R75 000). However, you will be liable to pay the R75 000 plus interest over the contract term if you want to buy the car after the term is up.
How Is Residual Value Determined?
Residual value is determined by the financier or dealer based on market analysis. This market analysis takes into account historical resale data, current trends, and future projections. Factors like make, model, variant, mileage, condition, demand, and replacement cycle all affect residual value.
Premium vehicles and brands known for quality and durability tend to have higher residual values in South Africa.
Residual Value Impact on Financing
Residual value significantly impacts the monthly instalments on car finance deals so that they are a lot lower. A higher residual means even lower instalments, as it is assumed the car can be sold at the end of the term to cover the remaining amount owed. At the end of the term, buyers can choose to keep the car, trade it in, or sell it themselves if market value exceeds residual value.
The thinking behind a residual is that when you trade in your car after the term of the contract its value is equal to the residual. This would mean you won’t have to pay in the residual because the value of your car covers it.
Pros and Cons of A Residual Option
Pros of a residual include that if you can only afford a certain amount each month but really want a particular car, you could perhaps afford it if you opt for a residual. If you don’t have a deposit as a first-time buyer then a balloon or residual is your next best bet in terms of affordability. Another pro is that a buyer has the choice to keep the vehicle at the end of the agreement period or to simply give it back to the bank or lender and end all payments.
However, there’s always a market risk if resale values change and the actual value ends up above or below the residual estimate at the end of the term. Buyers should research historical resale values online to better understand potential residual risk. Buyers also take a risk as they may have to pay a large amount at the end of the contract or take another loan to refinance the residual.
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