How much is the right amount to balloon?
Two major things to take into consideration when putting your residual / balloon on your car finance (it actually works for assets as well).
- Cash flow:
We don’t want your repayments to put you into financial strain. Your monthly repayment is the most important figure when considering your new car. So many people focus heavily on the buy price of the car and don’t pay attention to the monthly repayment – which is the relevant figure.
A common question from the clients whom I have been able to educate is “I have $1000 to spend, what can I buy?”. That is always a good place to start when gaining information on affordability of a vehicle BECAUSE as soon as old-mate emotion becomes involved, that lovely base level Mercedes all of a sudden has an AMG kit and Go Faster stripes and you end up trying to fit a car under a repayment value by increasing the residual amount. In most cases, this is the worst thing you can do unless it is a specialist car, banking on a high on-sell value of your car is a risky proposition. Which brings me to the second point.
- Insuring against the future
I have a portfolio of clients who I speak with personally, and who I will speak to again in another 3-5 years when they are ready for their next car. If I allowed my clients to become emotional around the structure of the finance, putting in high residuals so they can afford the car they shouldn’t be buying, down the track we will find ourselves with negative equity. Negative equity is when you might have a car that is valued at $20,000 yet a residual value of $30,000 which you still owe. This is never a good conversation to have with a client and we do everything we can to avoid this situation. Sure, we can’t always get this right as some cars hold their value better than we expected and some cars depreciate better than we expected but by following these three steps you will insure yourself against monetary pain later:
i. If you are financing a regular car (specialist cars aside) 30% residual over 5 years is the maximum you should consider.
ii. Where possible, have options such as a sunroof, nice wheels and sat nav as these are the three optional extras that have been proven to decrease depreciation. PLUS, don’t buy a luminous purple car (self-explanatory). Ask your broker for an explanation for why they advise you on a certain finance structure and what has lead them to a particular bank / lender.
iii. Finally, make your repayments as high as you can afford, and the residual as low as you can afford – not the other way around.
At the end of the term, on a residual, you can simply a/ re-finance it over a period of time or b/ sell the car privately – in which you will be liable to pay the balance owing first or c/ trade the vehicle in against a new one. If we work through this strategy properly – when it comes to B and C, there will be equity in your car for the good guys. If you have become too emotional or a bad broker has put you into a deal with a very large residual, you may well find negative equity occurring. I’ve said in the past to be wary of in-house car finance companies because I believe they are structuring the deal to keep you in that brand rather than doing the right thing for you. Common things to be aware of here are interest rate conversations, see here.
A beautiful recent example of a structure done correctly is for our good friends at Agero Group. We decided to decrease the residual value in line with monthly budget. At the end of the term we owe $15,000 on a vehicle worth $30,000. This is a much easier conversation to have than if the car was worth $15,000 and we owe $30,000. From here every option looks rosy.
Just to summarise, don’t get emotional (this is very hard, I wholly understand) about trying to buy a car that you cannot afford through simply inflating residuals. Feel free to get in touch with any questions or if you just want to run some numbers by us. I genuinely want the best for you and anything I can do to help, I will.