Balloon Payments

Thursday, 16 January 2020 by John Rickard

A Balloon Payment is a larger than normal payment made at the end of a Loan.

Quite often in finPOWER Connect the actual Balloon Payment is a few cents lower than the value entered. This is because Payments and Interest can only be debited/ credited to a Loan Account in whole cents. The net effect of the rounding is the Balloon Payment is adjusted to compensate.

Note, the actual Balloon Payment amount entered is stored on the Loan calculation information - and is therefore available to view.

In finPOWER Connect 3.02.04 we have introduced a new setting to adjust the final regular payment to try and hold the Balloon Payment to that entered.

Normal (Non-Balloon Payment) Loans

Firstly, it is worthwhile reviewing how a normal Loan works.

  • The Final Payment may be different from the Regular Payment
    • It will always be less than or equal to the Regular Payment
    • This occurs where Interest calculations mean the balance would end up being non-zero if the Final Payment was the same as the Regular Payment
    • Remember only whole cents can be transacted to an Account
  • finPOWER Connect only stores the Regular Payment
    • The Final Payment shown is simply from the original calculation's schedule

Once a Loan is running anything could happen to the Loan.

  • If the Loan is paid on time, with no other charges being made, then the payments will be as per the original schedule
  • When a payment due is processed it is limited to the balance + accruals
    • This effectively means the Final Payment, due on maturity, is limited as per the original schedule
  • But, say a $5 fee is added (and is not due immediately)
    • This means the final payment would be the full regular payment and there would be a small additional payment required next week/ month
    • Or there could be a payment arrangement made to cover this

Gone are the days where systems could tweak the Interest transaction, e.g. to add a cent to make it balance.

Residual Value

A Loan with a Residual Value, as opposed to a Balloon Payment, is very similar to a normal Loan. They still have a payment on the maturity date.

The difference is, that instead of trying to limit the final balance to zero, it is limited to the Residual Value.

Balloon Payment

Typically only the Balloon Payment is due on maturity, therefore it is limited so the Loan balance ends up at zero (or the Residual Value). So, this may mean the Balloon Payment could be adjusted down a cent or two – just like a normal Final Payment, as described above.

There is an option to include the Regular with the Balloon Payment. In this case the combined regular + balloon may be adjusted – just like a final payment is adjusted.

Remember, we cannot fiddle the final Interest value – but - can we adjust the final regular payment before the balloon to hold the balloon to what we entered?

Of course we can try.

For example, if the Balloon Payment entered was $500.00 but is then adjusted to $499.99 – then why not just update the final regular payment – subtracting one cent from it. This can be done using an overriding payment – but would be slow manual process.

This will typically work - but, when an earlier payment is adjusted then the Loan balance changes, therefore the interest can change!

For example, if the final interest is $10.00, but was calculated as $10.00499999 and rounded down, then even a one cent change in a previous payment would mean interest would increase to say $10.00500000 – and therefore round up to $10.01– and then the payment tweak does not work.

Potentially any example could exhibit this, but obviously the longer the interest period and the higher the interest rate the greater the change in interest will be.

This technique, therefore, is NOT foolproof.

Also, the Loan will now show 3 differing payment values, one for regular payments during the term, one that is slightly lower for the penultimate payment and then the final balloon payment. This may be fine if the Loan is paid by Direct Debit, but otherwise may be confusing for the borrower.

If an overriding payment was used to bring the Balloon Payment into line with what was entered – what are the ramifications once the Loan is opened?

  • If the Loan is paid on time, with no other charges, then the payments will be as per the original schedule and everything works as expected
  • But, if an additional fee or interest accrues, the overriding payment comes into play and it will not work like a normal Loan – i.e. the final Regular Payment will remain overridden
  • Payment Arrangement may be more complicated, for example, do you remove the overriding payment first?

New Account Type option

A new setting has been added under the Payments page on an Account Type, check "Adjust Final Payment before Balloon Payment?". This simply automates the overriding payment method described above.

  • An Overriding Payment of Type "Adjustment (Final before Balloon)" (rather than "Regular") may be added to adjust the final Regular Payment
  • This is done so the calculation engine knows which item was added by a calculation
    • Whenever a new calculation is made all these items are firstly removed

The same issue arises where the adjustment does NOT work because of rounding issues - as the adjustment is not on the maturity date of the Loan. In this case the overriding payment is not added and the Balloon Payment will still be adjusted down. Therefore, you should carefully consider whether you wish to use this new setting.