What is a Bullet Loan?
A bullet loan is a loan that does not amortize over time and must be repaid with a single large payment (also called a balloon payment) at the end of the term of the loan.
How Does a Bullet Loan Work?
Unlike a loan whose total cost (interest and principal) is amortized -- paid incrementally during the life of the loan -- a bullet loan's principal is paid in one sum at the end of the term. Sometimes the interest is collected as part of the bullet payment as well, though in many cases the loan is interest-only during the term of the loan with only the outstanding principal due at the end.
To illustrate, suppose someone takes out a loan for $1,000 that must be repaid in one year at an interest rate of 10% compounded annually. If this were a bullet loan, this person would have to pay $1,100 ($1,000 in principal plus $100 in interest) in one payment at the end of one year.
Why Does a Bullet Loan Matter?
A bullet loan provides the advantage of not having to immediately begin paying back the loan. This can be preferable for companies that have near-term cash flow issues. The borrower must, however, be prepared to repay the principal and interest in its entirety at the end of the term.