background
Welcome to Wall Street Prep! Use code at checkout for 15% off.
Wharton & Wall Street Prep Certificates
Now Enrolling for May 2024 for May 2024
:
Private EquityReal Estate Investing
Buy-Side InvestingFP&A
Wharton & Wall Street Prep Certificates:
Enrollment for May 2024 is Open
Wall Street Prep

Bullet Loan

Step-by-Step Guide to Understanding Bullet Loans

Last Updated February 20, 2024

Learn Online Now

Bullet Loan

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.

Throughout the borrowing period, the only loan-related payment is the interest expense, with no required principal amortization.

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.

Learn More → What is a Balloon Payment? (CFPB)

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.

dl

FREE: Get the Real Estate Technical Interview Guide!

Submitting...

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.

If structured as PIK interest, the principal is equal to the original debt capital provided plus the accrued interest, with the interest expense growing each year from the increased debt 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.

The Wharton Online
and Wall Street Prep Real Estate Investing & Analysis Certificate Program

Level up your real estate investing career. Enrollment is open for the May 13 - July 7 Wharton Certificate Program cohort.

Enroll Today

Risks of Bullet Loans and “Lump Sum” Amortization Schedule

The risk associated with bullet loans can be substantial, especially if the financial condition of the company has deteriorated.

If so, the large one-time payment owed at the end of the loan’s term might exceed how much the company can afford to pay off, which can lead to the borrower defaulting on the debt obligation.

Given the risks, bullet repayments are rather uncommon relative to other debt structures – although they are most often in real estate lending – and these debt instruments are typically set up for a relatively short duration (i.e. up to only a handful of years at most).

However, in the time span that the only debt-related payment is interest – assuming it is not PIK – the company has more free cash flows (FCFs) to re-invest into operations and fund plans for growth.

To alleviate the concerns of default risk, lenders of bullet loans frequently offer refinancing options with conversion into a traditional amortizing loan.

Comments
0 Comments
Inline Feedbacks
View all comments

The Wall Street Prep Quicklesson Series

7 Free Financial Modeling Lessons

Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.