What is a Bullet Loan?
A bullet loan is a type of loan in which the principal that is borrowed is paid back at the end of the loan term. In some cases, the interest expense is added to the principal (accrued) and it is all paid back at the end of the loan. This type of loan provides flexibility to the borrower but it is also risky. In a debt schedule, periodic expenses would only consist of interest expense and no principal payment, as this is consolidated at maturity.
All of these terms essentially mean that a borrower is going to be saving a large payment until the end of the repayment term. With a bullet loan, borrowers can get access to loans they would not be able to afford otherwise.
Below is an example of principal repayment profiles for various different types of loans.
Source: CFI’s Free Corporate Finance Course.
One of the primary advantages of this type of loan is that it provides flexibility to the borrower. When an individual is trying to shop for a loan, he or she might find that the loan payments are too high to afford. By getting a bullet loan, the individual can significantly reduce the amount of money that will be due on each payment. In many cases, the borrower is only going to have to pay for the interest that is accruing during each period.
A bullet loan will sometimes also include the interest that is accruing in the amount that is due at the end of the loan. When this happens, the borrower is not going to have to make any payments until the end of the loan. This type of loan is less common, but it can be used in some circumstances.
Even though this type of loan can be beneficial, it is also extremely risky. Many borrowers have faced issues with this type of loan after getting involved with one. One of the biggest problems is that many borrowers do not make the proper arrangements to be able to make the balloon payment at the end of the loan term. The balloon payment comes due and the borrower does not have the money to repay it. In that case, the lender will foreclose on the property that is securing the loan.
This type of loan is also refinanced quite frequently. Borrowers often use the loan to get quick access to the money they need. They then take advantage of the small monthly payments associated with the bullet loan. When the balloon payment comes due, they will refinance into another loan.
Thank you for reading the CFI guide to bullet loans and their pros/cons. To keep learning and advancing your career as a world-class financial analyst, these additional resources will be a big help: