You’ve chosen the perfect car and now it’s time to sign on the dotted line. When it comes to financing, knowing your options can help you make the right choice. One option that may be available is balloon financing. Here are some things you’ll need to know if you’re considering balloon financing.

What Is Balloon Financing?

As the Consumer Financial Protection Bureau points out, the term “balloon” refers to a finance contract  in which you’ll have a large, one-time payment at the close of the term. This typically means monthly payments that are generally lower  than with traditional financing  leading up to the final, larger, balloon payment due at the end of the finance contract. This way, consumers spend less on a month-to-month basis, but are responsible for the balance left on the finance contract at a predetermined time.

To better illustrate this idea, let’s look at how a balloon mortgage works. Typically, these home loans have terms of five or seven years, while the payment is still calculated based on a 30-year amortization, according to Bankrate.com. You can enjoy lower payments over the term of your loan, but once the term is up, you’ll have to plan for the possibility of selling or paying the outstanding amount owed through refinancing the loan – if you qualify – or paying with your own funds. The same principle holds true with balloon auto financing; there’s a predetermined term with fixed installment payments until the final lump sum is due. As with a mortgage, you will have to pay the balloon amount, and that may result in you having to sell your car or refinance.

What Are the Advantages of Balloon Financing?

When you choose balloon financing, your monthly payments are typically lower than payments in a traditional finance contract, however the APR rate is generally higher.  This can provide flexibility to better manage your cash flow throughout the term of the financing. As WiseGEEK.com points out, financially savvy consumers can use that extra cash in their pockets each month however they choose, anything from investments to other expenses.

What Are the Disadvantages of Balloon Financing?

It can be very intimidating to see one large lump sum of money due at the end of your finance contract. A balloon financing contract could be advantageous only if you are prepared to have the money necessary to make the balloon payment when it is due.  You may be able to satisfy the balloon amount by trading in your vehicle.  However, because vehicle resale values and credit conditions may change, you should not rely solely on your vehicle’s potential future trade-in value when considering your ability to make the balloon payment.  For example, if the trade-in value of your vehicle ultimately is less than the balloon amount, you’ll have to pay the creditor the difference.  To make this work for you, it requires a lot of planning and consideration.

Balloon financing can be a viable option to those looking for auto financing. As with any financial decision, it’s important to research your options and consider your unique situation. Once you have all the facts, you can determine what the right choice is for you.