With a Personal Contract Purchase (PCP) agreement, one of the options at the end of your loan term is to make what is known as a balloon payment. Most people choose not to pay this, but instead enter into a new PCP contract. But is making a balloon payment a better option? We’ve explored some of the advantages and disadvantages of balloon payments below!
How Does PCP Work?
Personal contract purchases are the most common ways to finance a car. This is perhaps due to their flexibility, as well as the low monthly payments. Around 75% of all cars bought on finance are through a PCP arrangement. If you’re considering taking out vehicle finance, PCP can be a great option, but how exactly do these loans work?
Similar to any other type of loan, with PCP you’d be making monthly instalments. What sets a personal contract purchase loan apart is that you’re not contributing to the cost of the vehicle itself. Instead, you’re making repayments towards the depreciation of the car. For instance, with a car worth £8,000 at the point of sale, if it’s estimated to be worth £3,500 at the end of the contract, you’d be paying £4,500 in depreciation.
Once the term comes to an end, you then have a few options to choose from. Many people decide to return the car, and then enter into a new PCP agreement, with a new make and model of vehicle. You can alternatively hand back the keys and walk away completely, or make the balloon payment. In the example above, this would be a payment of £3,500.
How Much is a Balloon Payment?
The balloon payment at the end of your loan term will be the vehicle’s estimated value at this point, which is determined at the start of the agreement. Generally, this will be at least a few thousand pounds. It’s not always easy to save up for such a payment, especially as you’ll be making monthly instalments towards the loan anyway. You may therefore need to take out another loan to cover the balloon payment.
If you did want to spread the cost of the loan, a Hire Purchase (HP) agreement would probably be a better option. With a HP deal, your monthly instalments go towards the value of the car, rather than the depreciation, so once you make your final payment, you’ll own the vehicle outright. Though it should be noted that the monthly payments tend to be higher with HP, when compared to PCP.
Benefits of Balloon Payments
As mentioned above, the majority of people return their vehicle when their PCP contract finishes. But some people do choose to make the balloon payment, and this option comes with a number of advantages. The main benefits include:
Make a Profit
It’s worth bearing in mind that the balloon payment doesn’t fluctuate with the market. Once you’ve been given a figure, that’s how much you’d need to pay at the end of the contract. This can sometimes work to your advantage. If your car is worth more than estimated when your term finishes, you could make the balloon payment and then sell the vehicle for a profit.
You can improve the chances of this happening by keeping the car in great condition, driving fewer miles than contractually agreed, and investing money in quality new parts and repairs. If your vehicle is a particularly desirable model, it may retain its value better too. And perhaps you’ll get lucky – things like new emission taxes could impact the worth of your car.
Love Your Car
For some people, PCP contracts are a great way to get the newest, flashiest car on the market, for a reasonable price. But not everyone is like that. Sometimes you fall in love with the car you’re driving. If it’s reliable, has all the features you’re looking for, and still has plenty of miles left on the clock, you may not want to hand back the keys.
If you make a balloon payment at the end of your contract, you’ll be getting a vehicle you already know inside out. So don’t feel pressured to enter into a new agreement if you’d rather just keep the car you have.
No More Instalments
Taking out a new PCP deal does mean that you’ll continue to make monthly payments for another few years, throughout that contract. Over time, your instalments will add up, and you may have been able to save enough money to buy a car outright anyway. Not to mention the fact that your situation may change in this time, making the repayments more of a struggle.
Paying the balloon payment will mean you won’t have anything to repay, and you can put that money towards something else each month, or simply start saving. Even if you take out a loan to cover the cost of the balloon payment, you’ll have a definitive end date in sight.
Limitations of a Balloon Payment
The obvious drawback of a balloon payment is the large cost, which needs to be paid in full. If you intend to go down this route from the start, you might be able to save up the amount needed, but it may be too expensive. There is a good chance that you’ll have to borrow from a short term lender to cover the cost.
Another limitation of balloon payments is that there will be a completion fee to pay, on top of the balloon payment itself. You can find out how much this would be by checking the small print in your original loan contract.
You should furthermore be prepared for your dealer to be in regular contact with you regarding the balloon payment. It would be more beneficial for them if you take out a new contract, so the dealer is bound to get in touch with all sorts of offers that may be hard to resist. Even if you’d made up your mind to make the balloon payment, you could be swayed by great deals.
Overall, whether you pay the balloon payment or not should be your own decision. You should carefully weigh up your options, and determine which option is right for you – don’t be influenced by the lender or dealer!
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