What is a Bullet Loan?
For a Bullet Loan, the entire principal of the debt obligation is repaid in a single, “lump sum” payment on the date of maturity.
How Does a Bullet Loan Work?
Loans structured with bullet repayments, also known as “balloon” loans, are when the repayment of the original principal is fully made at the end of the lending term.
Then, on the date of maturity, the one-time large payment obligation coming due is the so-called “bullet” repayment.
In effect, a bullet loan comes with lower payments in earlier years until the date the principal repayments come due, but the company has time (and additional capital) in the meantime.
Bullet Loan vs. Amortizing Loan: What is the Difference?
To the borrower of the bullet loan, the flexibility afforded is a major benefit – i.e. no (or very minimal) principal amortization until the loan matures.
By obtaining a bullet loan, the amount of financial obligations is reduced in the near term, although the debt burden is actually just being pushed back to a later date.
Rather than the gradual repayment of the loan principal over the borrowing term, as seen in amortizing loans, one lump sum repayment of the loan principal is made on the date of the maturity.
How Do Full Lump Sum Bullet Loans Work?
Considering how customizable bullet loans tend to be, the interest can be negotiated to be in the form of paid-in-kind (PIK) interest, which further increases principal due at maturity (and the credit risks) as the interest accrues to the ending balance.
The interest will accrue based on the contractual lending terms (e.g. monthly, annually).
How Do Interest-Only Loans Work?
In contrast, for an “interest-only” bullet loan, the borrower must service regularly scheduled interest expense payments.
By the end of the term of the loan, the lump sum payment due at maturity is only equal to the original loan principal amount.