What is a bullet loan?
A bullet loan is a loan type in which the loan amount is due for repayment in one amount at the end of the agreed loan term. This is also the origin of the term “final maturity”. A bullet loan is also called a repayment-free loan because no repayment of the loan amount takes place during the loan term and is therefore not repaid. During the term of the loan, the borrower only has to pay the agreed interest.
The practice
In practice, such a bullet loan is often linked to the conclusion of a building saving contract or a capital life insurance policy, in which the borrower then pays in during the term. If the loan then becomes due at the end of the term, this sum should then come from the concluded endowment life insurance or from the building saving contract and be redeemed with this sum. The independent consumer protection organisations do not assess such couplings positively, because the conclusion of an additional contract incurs further and additional administrative costs for the borrower and often does not overrule the maturity of such contracts with the date of repayment of the loan. Nevertheless, in practice it is often implemented in this way.
Interest and usage type
The interest on the bullet loan is either fixed or variable. Such loans are mainly used for interim financing. In practice, the banks transfer the contracts that will later be used to repay the loan. This type of loan is also used to finance a house. When financing a loan, there are basically two options for the house buyer. He can repay his loan at regular intervals in the form of installments. This is also from a redemption loan or annuity loan. The second option is a repayment-free loan (i.e. a bullet loan). The second option usually only makes sense for rented real estate, because the interest for the external financing is tax-deductible there. If the owner of a house takes out such a loan, it is not possible to deduct the interest for tax purposes. Therefore, the repayment loan is used in such a case.
Advantages and disadvantages of this type of loan
A bullet loan is mainly used when it comes to financing investments in a company. There, the resulting depreciation is used for repayment. This also reduces the credit risk for the lender as the loan term progresses. The same effect also occurs with consumer loans in this form, which are paid for out of the borrower’s monthly income.
Similarly, repayments may also be made in the form of a sum of saved liquidity reserves from the project financed by the loan. However, the credit risk for the lender remains unchanged throughout the entire term.
The disadvantage for the borrower is that a comparatively higher interest burden arises with such a loan because there is no regular repayment of the loan amount. There is also the disadvantage that the borrower has a one-off high liquidity burden on the due date compared to other forms of loan. In the case of corporate financing, the high financial burden at a given date may be reduced or offset by anticipated income from the sale of current or non-current assets or by further follow-up financing.