How Balloon Payments Work for Heavy Equipment Financing

Financing can be confusing. If you’ve ever thought to yourself “How does a balloon payment work?” when financing a new piece of heavy equipment, you’re not alone. While some owners and fleet managers understand the ins and outs of financing heavy machines, others aren’t as well-versed — and with so many terms and available options out there, it’s easy to understand why.

We’re here to answer all your questions around balloon payments and financing1. We’ll first help you better understand balloon payments in general, then what it might mean for you to add one to your next heavy equipment purchase.

What is a balloon payment?

A balloon payment is an oversized payment due at the end of a loan designed to lower monthly payment amounts throughout the life of the loan. At the end of the term (maturity), the borrower has two options to address the balloon — either make the payment in full or refinance the amount based on standard lending guidelines at that point in time.

Why choose a balloon payment for your heavy equipment loan?

  • Keep monthly payments low
  • Free up cash flow for other business needs
  • Own the machine throughout the loan term2
  • Enjoy no turn-in conditions

How does a balloon payment work?How does a balloon payment work?

This example shows you how a typical balloon payment added to the financing on a new piece of construction equipment might look.

The average amount to finance a machine is around $235,000. For a 48-month term, an owner could expect to pay $5,098 each of those months to finance it. However, if he chose to add a balloon to the loan — in this scenario, 40% of the total cost or $94,000 — he should expect to pay $3,351 for the first 47 months, at which time the balloon payment of $94,000 becomes due as his final payment. His payments using the balloon option decreased by $1,747 each month, freeing up cash flow for other business needs throughout the four-year term.

Do only certain customers/buyers qualify for a balloon option?

Loans with balloon options are typically reserved for above-average credits since there’s more credit risk associated with the larger contract balance throughout the loan.

Understand that with a balloon payment, it’s not a fully amortizing loan. That means over the course of the loan, your finance company is in a more precarious position on the machine because the customer is sending in smaller payments due to the “nut” on the end (i.e. the balloon payment). So if your finance company had to repossess the machine — let’s say at month 18 in a 48-month transaction — its loss would be much larger which can be attributed to the difference between the contract balance and market value of the machine at that time.

How do leasing and loans with balloon payments differ?

You should consult your financial or tax advisor for the accounting benefits associated with a loan versus a lease. From a pure monthly payment standpoint, a lease would more closely resemble a loan with a balloon. Note that the “balloon” in the context of a lease is called a residual, and the customer is not obligated to purchase (it’s presented as an option).

Referring back to our example scenario above, by paying $3,351 per month as opposed to $5,098 a month, you can see that the machine isn’t being paid down as quickly — even though the owner may be using it every bit as much as he would if he had a contract without a balloon payment. That’s why leasing is typically reserved for a better credit quality, because there’s a huge residual on the end — and a loan with a balloon is no different. Again, the primary difference between a balloon loan and a lease is the fact that customers can walk away from the lease at the end of term. On the loan with a balloon payment, they’re due for it.

What will adding a balloon payment do to my interest rate?

Interest rates are generally higher for loans with balloons due to the lender holding a larger balance throughout the loan term.

Again, I always like to compare it to a lease, because it’s very similar aside from some accounting items. But take, for example, why leasing cars is so popular. Let’s say you want a $50,000 car, and the residual value is $25,000 after 36 months. You’re only paying for $25,000 of that vehicle as opposed to $50,000. So your monthly payment is going to be a lot less on a contract with a balloon or a residual, because you’re not paying for the entire asset over the course of that term. The lender is taking risk on a larger balance, which correlates to a higher rate.

How is the final balloon payment amount determined?

Guidelines exist based on machine value, term and your credit quality. In some situations, finance companies can tailor the balloon to best meet your needs. For example, you may have a monthly payment target in mind, and typically lenders are able to achieve that by adjusting the balloon.

When it comes to balloon amounts, however, lenders have a ceiling. Obviously, you shouldn’t expect to get a 36-month contract with a 90% balloon. Generally, you could expect 60 months with a 20% balloon, 48 months with a 25% balloon, 36 months with a 30-40% balloon, and so forth. Balloon payments usually can be tailored to best align with your payment amount goal if you’re managing to a specific project or something similar.

Volvo Wheel LoaderDo balloon payments apply to the purchase of only a single machine or can they be used to buy multiple pieces of equipment?  Balloons apply to one or more machines and can be documented on one or multiple contract schedules, depending on your preference. Typically, if there’s going to be multiple assets on the contract, each machine will have its own balloon payment, so the lender knows exactly how much is due on that machine at maturity.

The pandemic has brought a level of uncertainty to the construction market. Why are balloon payments particularly attractive right now? 

Loan structures with balloons typically offer a lower payment addressing customer cash flow concerns related to economic cycles or project/operational uncertainties.

Balloon payments can help manage equipment expenses if there are project uncertainties like lockdowns. Referring back to our scenario, most owners would prefer the $3,300 monthly payment if a project is on hold for two months versus a $5,000 payment. Balloons help them preserve cashflow while managing equipment expenses during times like this.

Can I sell or trade my machine at any point in the term?

Yes, you can request a payoff that will include the balloon payment and any outstanding payments.

If I’ve already purchased a piece of equipment and a year in I experience a project shutdown, can I refinance my machine to add a balloon and lower my payments?

Yes, it’s called a modification. While you’d rarely see a customer at any point in the term elect to add a balloon, lenders can offer other options like skipped payments or even extend the term. Lenders in the construction industry, like Volvo Financial Services, want to keep customers in their machines, so we do what we can to ensure customers can afford their machines through economic ups and downs.

Can I walk away from a balloon?

No, a balloon payment is an obligation and should be considered an oversized payment due at maturity.

How do the monthly payments on a loan with a balloon compare to rental payments?

A loan with a balloon payment is typically a lot lower than a monthly rental payment. 

To balloon or not to balloon — here are some additional key points to consider:

  • Loans with balloon payments are focused on building ownership in the machine, but with the added benefit of a lower monthly payment.
  • When deciding on the balloon payment amount, determine your confidence in the machine’s value at contract maturity. For example, will the machine have a higher market value than the balloon amount if you sell or trade it in?
  • If you’re considering a lease, but you’re concerned with lack of flexibility (return conditions and early termination), a loan with a balloon payment can achieve payment semblance without the concerns related to lease turn-in obligations.

Don’t think you have to be a financial expert to weigh all your options. Even knowing the basics can oftentimes give you the confidence to discuss all your financial options with your lender when the time comes.

In the meantime, if you have additional questions about balloon payments or how they might benefit your next heavy equipment purchase, please fill out the form below and we’ll make sure one of our financial experts gets back to you promptly.

Rent, Lease or Buy — What’s the Best Option for Construction Equipment?

Rent, Lease or Buy — What’s the Best Option for Construction Equipment?

Economic conditions and market uncertainties have big impacts on whether it's the right time to add equipment to your fleet ...

¹ Consult with your accountant or tax advisor for any accounting and tax implications related to balloon payments.

² Customer owns machine through entire term. Lien released at end-of-term upon payment/refinance of balloon.


Written by Kenneth Borgeson – Commercial Strategy, Construction Equipment Financial Services
Volvo Financial Services

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