Sara Routhier, Managing Editor and Outreach Director, has professional experience as an educator, SEO specialist, and content marketer. She has over five years of experience in the insurance industry. As a researcher, data nerd, writer, and editor she strives to curate educational, enlightening articles that provide you with the must-know facts and best-kept secrets within the overwhelming world o...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Jun 5, 2012

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A recently proposed bill in North Carolina’s legislature would allow certain auto loans to conclude in a final balloon payment. Balloon payments are a mechanism more commonly found in real estate arrangements, but North Carolina may blaze the trail of taking this practice in the auto sector.

The bill, more formally referred to as House Bill 1155, was proposed by Rep. Tim Moore, a republican and the co-chairman of the state’s Rules Committee. Since its announcement last week, the bill has received a harsh public backlash.

“It will lead to many people getting unaffordable loans that will end in default, and repossession of the car, and ruining their credit score and a whole host of other problems,” said Al Ripley, the director of consumer and housing affairs at the N.C. Justice Center, according to News Observer.

Ripley added that originating oversized auto loans will become a predatory lending practice and enabling such activity involves “the same kinds of tactics that contributed to the financial crisis in the housing market.”

Auto loans that conclude in a final balloon payment refer to a type of financing that is structured to allow for consistent and affordable payments. But the loan is meant to crown with an existing balance, and, come the final payment, the borrower will owe the remaining balance in one lump sum.

That last payment, referred to as the balloon payment, is where this type of financing gets its name.

To get a grasp on how these arrangements work in the real world, Chris Kukla, senior counsel for government affairs at the Center for Responsible Lending, gave an example of what a traditional auto loan and a balloon auto loan of the same amount would like side-by-side.

Imagine a borrower who paid roughly $26,000 for a vehicle with a five-year loan at 8 percent interest. That would require monthly payments of $528, and the loan would be completely satisfied after 60 months.

But if that same borrower agreed to a balloon auto loan, he or she would be given a lower monthly payment. If North Carolina’s proposed bill is passed, this borrower would have their payments scaled back to $400. Come this borrower’s 60th payment, however, he or she would owe a $10,000 balloon payment.

“The practical effect of this is that, essentially, you are underwater pretty much the whole time you are in the loan,” said Kukla, alluding to the fact that the amount of the loan would exceed the value of the vehicle the entire time the auto loan exists.

After hearing the growing public outcry over this bill, Rep. Moore said that he’s interested in getting more feedback from consumer groups, auto dealers and financial dealers before moving forward.

If he finds the cons outweigh the pros, then, he said, “we can forget about it.”