Addendum, Oct 2017: I have further simplified this article for the benefit of the many visitors every month. This article is one of the highest hit articles on my blog, and it is actually a bit worrisome that even banks have joined in to offer the scheme now. The MAS rules for car financing have also changed, so many of the figures have been updated to be current. Please support me by clicking on ads that interest you. It will help me keep this blog alive and allow me contribute more articles to the Singapore motoring community.
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.”
But before reading on, please take some time to understand the Singapore vehicle taxation structure. Without that knowledge, it may be difficult to understand some of the terms used here.
So what is a Balloon Scheme?
The Balloon Scheme is deferred payment scheme designed to reduce the monthly instalment sum. The flip side is high interest rates and a large sum to pay at the end.
Technical details: The interest rate is applied to the full loan amount, and then the minimum PARF rebate (or “scrap value”) is deducted before dividing into monthly instalments.
The lower monthly instalments make it seem extremely favourable especially if you are buying an old car, but I would suggest to avoid balloon schemes. Why?
Example of calculations
Let’s say you bought a used car for $100K and intend to get a 5-year loan for $60K. The car has a min. PARF value of $10K.
| Typical Loan | Balloon Scheme | |
|---|---|---|
| Car price | $100,000 | $100,000 |
| Min. PARF | $10,000 | $10,000 |
| Down payment | $40,000 (40%) | $40,000 (40%) |
| Loan amount | $60,000 (60%) | $60,000 (60%) |
| Interests | $5,640 @ 1.88% x 5 years |
$8,040 @ 2.68% x 5 years |
| Total Instalments Payable | $60,000 + $5,640 = $65,640 |
$60,000 + $8,040 – $10,000 = $58,040 |
| Instalments (Monthly) | $1,094/mth | $967/mth |
| Final Instalment | $1,094 | $10,000 + $967 = $10,967 |
That’s a $127 reduction in installments! Yeah! Let’s do that balloon scheme now!
But wait… in addition to the extra $2,400 in interests paid, there is also a final sum of $10,000.
The implications of the final sum
If the COE expiry coincides with the end of the loan period then it is fine because the min. PARF rebate from the government would cover the final sum, but what if…
What if the car has several years to go?
You will have to cough up this $10,000 to keep your car. Or you’ll have to dispose the car prematurely and you will stand to lose even more (see below).
What if you were stuck in a bad financial situation?
In an event that you have to dispose (i.e. sell) the car prematurely before the end of the loan term, you will likely suffer even more financial losses.
Early disposal
Here is an illustrated example of an early disposal/sale.
| Selling at 8th year | Selling at 10th year | |
|---|---|---|
| Car price | $100,000 | $100,000 |
| Sale price | $20,000 | $10,000 (Min. PARF) |
| Years | 8 years | 10 years |
| Depreciation | ($100,000 – $20,000) / 8 = $10,000/yr |
($100,000 – $10,000) / 10 = $9,000/yr |
It is clear that selling the car at the 8th year would have cost the owner and additional $1,000/yr over 8 years, that is total of $8,000! This has not taken into account any financial charges and fees should the car be disposed even before the end of the loan term. (Read up on the Rule of 78 if you would like to find out more.)
The reason for this is because an older car should depreciate less, so the price of the car dips more than it depreciates (in a straight line) as it ages. There are some specific situations, however, that this may be not true and will depend largely on market forces at the time of sale, e.g. high COE prices would result in high car prices.
Final words
If you have to use the balloon scheme to afford a car, chances are that you are stretching your finances.
The two biggest purchases in our life would likely be a property and a car; but unlike property, a car in Singapore is not an asset. It depreciates in value quickly from the moment you buy it.
My advise would be to avoid the balloon scheme and find a car that you can comfortably upkeep.
Addendum, Oct 2014: Do also read the updated article I wrote here in 2014: How to buy a used car in Singapore