Balloon scheme (loan) is not what it sounds like

I came across a loan scheme called the “balloon scheme” recently. Some people say this loan scheme existed a long time ago, but I have not heard of it until recently so it’s new to me.

My first thought – wow, these financial tools will evolve in 101 ways just to get people to take a loan.

* Before I go on, please do take some time to understand the Singapore vehicle taxation structure. Without that knowledge, there’s no point trying to understand the financial implications that result.

Just to quickly summarize what it does:

The balloon scheme is a loan scheme whereby a higher interest rate is applied to the primary loan amount and then the minimum PARF rebate is deducted before dividing the loan into monthly installments.

The end result is lower monthly installment and makes it seem extremely favorable especially if you are buying an old car.

Many car buyers only look at the monthly installments because that’s the easiest to understand. And that’s when a lot of people make mistakes with their financial commitments and turn away from old cars because the installments remain pretty much the same. Why?

As a quick example, let’s compare:

$108K, 2 years old VW Scirocco:
Principal + Interest: $108K + ($108K x 1.88% x 8 yrs) = $124,243
Monthly repayment: $124,243 / 8 yrs / 12 mths = $1,294/mth

$140K, brand new car:
Principal + Interest: $140K + ($140K x 1.88% x 10 yrs) = $166,320
Monthly repayment: $166,320 / 10 yrs / 12 mths = $1,386/mth

So what the heck – the new car is only about a hundred bucks more a month, why not get a new car with warranty, yada yada yada?

Here’s why the old car is more financially sound:

• You are paying less interests on the old car due to a smaller principal sum and shorter tenure
• You are taking on less depreciation because the minimum PARF rebate remains constant irregardless of car age
• You will breakeven on your loan earlier

Caveat: Because of the current COE prices, new cars are very expensive. Once COE prices stabilizes in the next 2-3 years, old cars should have higher monthly installments than new cars given a full loan is applied on both cases.

So, what’s a balloon loan scheme? Let’s compare using the same $108K, 2 year old VW Scirocco:

Normal loan scheme, 1.88%:
Principal + Interest: $108K + ($108K x 1.88% x 8 yrs) = $124,243
Monthly repayment: $124,243 / 8 yrs / 12 mths = $1,294/mth

“Balloon” loan scheme, 2.68%:
Principal + Interest: $108K + ($108K x 2.68% x 8 yrs) = $131,155
Less minimum PARF: $131,155 – ($23,882 x 50%) = $119,214
Monthly repayment: $119,214 / 8 yrs / 12 mths = $1,242/mth

Now, this looks like a small difference but with an older car the difference is significant. Here’s another example with a coming 6 years old Nissan Latio, a typical uncle’s bread and butter car:

Normal loan scheme, 1.88%:
Principal + Interest: $37K + ($37K x 1.88% x 4 yrs) = $39,782
Monthly repayment: $39,782 / 4 yrs / 12 mths = $829/mth

“Balloon” loan scheme, 2.68%:
Principal + Interest: $37K + ($37K x 2.68% x 4 yrs) = $40,966
Less minimum PARF: $40,966 – ($15,027 x 50%) = $33,453
Monthly repayment: $33,453 / 4 yrs / 12 mths = $697/mth

That’s a $112 (15%) reduction in installments! Yeah, let’s go and buy this ballooned Latio right NOW!

But wait…

In an earlier post, I mentioned that down paying the PARF value is a must. By down paying the minimum PARF, you effectively do two things:

1. You lower your monthly installments and loan interests
2. You lower your risks by taking a loan on the depreciation only

The “balloon scheme” may sound like the same thing, but it is NOT. The final catch here is that you’ll need to pay the minimum PARF amount at the end of the loan. If you drove it till the end of 10 years, that’s not a problem — you’ll get your minimum PARF from the government. But if you need to dispose the car in a bad financial situation and don’t have that extra cash then you are in trouble because you have a higher principal sum AND interest.

For those who need a comparison, here’s a table of the differences.

	Normal Scheme w/min. PARF downpayment	Balloon Scheme w/$0 downpayment
Principal amount	Lower – downpaid the minimum PARF	Higher – took a full loan
Interests	Lower – 1.88%, smaller principal sum	Higher – 2.68%, larger principal sum
Repayment	Linear – paid everything by the end of the loan tenure	Deferred – must pay the minimum PARF at the end of the loan tenure
Early settlement	Pay less in penalties, break even early	Pay more in penalties, almost never break even!

So if you are considering taking a “balloon scheme” loan, I would strongly advise against it. If you are unable to downpay the minimum PARF, chances are you are not financially sound for a vehicle right now.

Sorry to burst your balloon! Truth hurts but it’s for your own good.

P.S. I wonder why they called it the “balloon” scheme. If I were to be designing financial plans I would have called it something like pay less scheme or lao hong scheme to make it more tempting…