A balloon payment on a car loan, and a residual value on a lease, do the same arithmetic from opposite ends. Both leave a lump sum owing at the end of the term. Both make the monthly payment smaller than it would otherwise be. Neither makes the car cheaper.
A balloon is a deferral, not a discount. The amount is not paid down during the term, so interest keeps accruing on it for the life of the loan — which is why Moneysmart's plain statement is that the total cost of the loan is generally higher. The second trap is that the residual is a fixed number set at the start, while the car's value at the end is not. If the car is worth less than the residual, the difference is yours.
What the lump sum actually is
On a loan, the balloon is the part of the principal you have agreed not to repay in instalments. On a lease, the residual is the value the financier books the car at for the end of the term, and the payments are calculated to cover the difference between the car's cost and that residual, plus interest on it.
The ATO's example of a bona fide novated lease shows the structure exactly: a $40,000 car on a three-year lease with a residual of 46.88% — $18,752 — where the lease payments over the term equal $40,000 minus the residual, plus interest on the difference.
So a larger residual means smaller payments and a larger cheque at the end. A smaller residual means the reverse. Nothing about it changes the price of the car.
The ATO sets a minimum, and the citation almost everyone uses is wrong
Lease residuals cannot be set arbitrarily low. If a residual is unrealistically small, the arrangement starts to look like a sale dressed up as a lease, and the tax treatment changes.
Minimum residual as a percentage of original cost
- 1 year
- 65.63%
- 2 years
- 56.25%
- 3 years
- 46.88%
- 4 years
- 37.5%
- 5 years
- 28.13%
These figures are widely attributed across the finance industry to Taxation Ruling IT 28. That attribution does not hold up. IT 28 is a 1960 ruling on leasing arrangements of plant and machinery, and its table of minimum residual values is a different one entirely — running from 60% in year one down to nil in year five for plant depreciated at 20% prime cost.
The schedule above is from ATO ID 2002/1004 Car lease residual values, for an asset with an eight-year effective life. That is the document the ATO's own car leasing and FBT page points at when it states that a bona fide lease's residual must not be less than the published minimums, and its worked example uses the 46.88% three-year figure.
The numbers are right. The citation is not, and if you are checking a quote against the source it matters which document you open.
The residual is calculated on cost, not on what you paid down
A second point from the same ATO material, and one that surprises people who put money down: a trade-in or a cash contribution must not reduce the lease payments or the residual.
In the ATO's example, Patrick contributes $1,600 towards on-road costs on a $41,600 car. The lease is written over the $40,000 the financier paid, and the residual is 46.88% of $40,000. In the counter-example, Sheila's $20,000 trade-in is used to cut the financier's purchase price and the residual with it — and the lease fails the bona fide test as a result.
If you are being shown a lease where your deposit reduces the residual, that is worth a question.
How negative equity happens
Negative equity is owing more than the car is worth. Three things produce it, and a balloon accelerates all three:
- Depreciation is front-loaded. Most cars lose value fastest in the first two or three years, while a balloon structure is paying down the least principal.
- Long terms. A seven-year loan on a car with a five-year useful life to you means years of owing money on something you no longer want.
- Rolling a shortfall into the next loan. Trading out of a car you still owe money on, and adding the shortfall to the new finance, starts the next loan already under water.
The consequence is the one ASIC documented in its 2026 review of car loans: when a car is repossessed and sold, the sale frequently does not clear the debt. In a sample of 250 such loans, 90% of borrowers still owed more than half the loan amount. That is the same arithmetic seen from the worst end.
Guaranteed future value is a different promise
Guaranteed future value looks like a residual and behaves differently. The lender guarantees a value at which you can return the car at the end of the term, so the risk of the car being worth less sits with them rather than you.
The guarantee is conditional. Moneysmart notes the usual conditions: an agreed kilometre limit, and returning the vehicle in good condition that is not beyond fair wear and tear. Exceed either and the guaranteed value is not what you get. Read what "fair wear and tear" is defined as in the contract, because that definition is the product.
What to do when the lump sum falls due
Broadly four options, and it is worth knowing which are available to you before the date arrives:
- Pay it. Cheapest, if you have planned for it.
- Refinance it. Common, and it extends the interest you pay on an older car.
- Sell the car and pay it out. Works if the car is worth at least the balloon. Check the number before you assume it.
- Hand it back, where the contract allows — an operating lease or a guaranteed future value arrangement, not an ordinary loan.
Before you agree to one
- Ask for the balloon or residual in dollars, not as a percentage
- Ask for the total of every payment plus the lump sum, and compare that to the total on a loan without one
- Form a view on what the car will be worth on that date, and be conservative — car depreciation in Australia is a reasonable starting point
- Have a plan for the payment that does not depend on the car being worth a particular amount
The wider comparison of finance structures is in ways to buy a car in Australia, and the fee side of a loan in car loans and dealer finance.