Balloon payments on equipment finance: what they really cost
The payment drops, the obligation does not. Here is the arithmetic that quote sheets rarely show.
6 min read
What is a balloon payment on equipment financing?
A lump sum deferred to the final day of the term, usually set as a percentage of the purchase price. It reduces the regular payment by removing that principal from the amortization, but interest still accrues on it throughout. On a $91,200 loan at 6.9% over 60 months, a $29,000 balloon cuts the payment from $1,797.40 to $1,390.26 — saving $407.14 a month, at a cost of $4,571.67 in extra interest, plus the $29,000 still to be found.
The payment falls, the debt does not
A balloon works by discounting the residual back to today and amortizing only the difference. You still pay interest on the full outstanding balance every period — the residual is simply never paid down.
That is why the monthly saving looks so attractive and the total cost does not. On the example above, the payment drops by 22.6% while total interest rises by 27.5%.
Neither number is hidden, but only the first one usually appears on a quote sheet, and it is the one a buyer anchors on.
The right comparison is total cost of the equipment across the term, not the monthly payment.
Three ways it ends, and one that goes wrong
On the final day you have three legitimate options: pay the residual in cash, refinance it, or sell the equipment for at least that amount.
All three are fine plans. What causes trouble is arriving at that date without having chosen one — or discovering the resale value has fallen below the residual, which leaves you owing money on machinery you no longer want.
That gap is the real risk of a balloon, and it is largest on equipment that depreciates faster than the residual was set to assume.
Check the likely resale value at term end before agreeing the residual percentage, not after.
Ask what basis the rate is quoted on
Canadian equipment lenders do not all quote on the same compounding basis. Some follow the mortgage convention and compound semi-annually; others compound monthly to match the payment. The quoted percentage looks identical either way.
On an $80,000 loan at a nominal 7% over five years, the difference between the two bases is $226.19 across the term. Not a fortune, but entirely invisible on the quote sheet — and between two lenders advertising the same rate, it decides which is genuinely cheaper.
The effective annual rate is the only figure that lets you compare quotes honestly.
It is a reasonable question to ask a lender, and the answer changes the arithmetic.
Match the payment frequency to your cash cycle
Monthly payments suit a business with even monthly revenue. Many do not have one — farm income arrives after harvest, and a fixed monthly draw through the winter is harder to carry than a larger annual or quarterly payment.
More frequent payments reduce total interest slightly, because principal falls sooner. Less frequent payments cost marginally more but can match cash flow far better.
The interest difference between frequencies is usually small enough that cash flow should decide it, not the total-interest column.
This is one of the few places where the obviously cheaper option is not obviously the right one.
What the payment calculation leaves out
The payment is the easy part of an equipment purchase.
GST or HST on the purchase price is often the largest single cash requirement at closing, even where it is recoverable as an input tax credit — it still has to be funded in the meantime. Then come PPSA registration, lender documentation fees, and required insurance.
If fees are being financed rather than paid separately, they earn interest for the whole term, so they belong in the amount financed rather than treated as a small extra.
On the tax side, financed equipment is normally capitalized and depreciated through the capital cost allowance system rather than expensed.
Your accountant should confirm the CCA class before you model the after-tax cost of the purchase.