A bullet loan, also known as a balloon loan, is a loan in which the principal (the original amount lent) is paid in one large amount at the end of the term (maturity). In some cases, the loan may involve interest only payments during the term, with the principal due at the end.
A bullet loan differs from other types of lending, where the borrowers’ installments throughout the term include principal and interest payments.
The large payment at the end of a bullet loan is called a ‘balloon payment’.
Bullet loans are useful for borrowers who expect to receive money later but currently have cash flow problems.
Imagine you take out a $10,000 loan that has to be repaid in 12 months with an annual interest rate of 7%. If this were a pure bullet loan, you would pay $1,000 principal plus $70 in interest in one payment at the end of the twelfth month.
Advantage of a bullet loan
For companies that have a serious short-term cash flow problem, not having to pay anything back immediately is helpful.
However, as the payment is a ‘balloon’ one, the borrower risks not having enough funds to cover it when the time comes.
If you need money, cannot afford to pay installments at the moment, and expect to receive some money in the future, perhaps an inheritance or a settlement, a bullet loan may be the right one for you.
Experts say this type of loan is highly risky, many believe that in some cases they are predatory.
Bullet loans were originally created to finance long-term investments by firms to help them grow or develop new business.
They became popular as mortgages, known as balloon mortgages, and typically had shorter terms than other fixed-interest mortgages.
Using a bullet loan to buy a home works well for people who cannot afford to pay high installments, as long as property prices rise. At the end of the term you can sell the property (which should be worth a lot more) or refinance.
When the 2008 financial crisis hit and property prices plummeted, many borrowers with bullet loans got into serious trouble.
Video – What is a balloon?
Some bullet loans have elements of conventional loans. In this video, the speaker explains how 30% of the principal is pushed to the end of the term, i.e. the borrower’s final ‘balloon’ payment would be thirty percent of the principal.