A bullet loan is a loan structured so that the borrower makes only interest payments during the term and repays the entire principal balance in a single lump sum on the maturity date. Nothing you pay along the way reduces what you owe. The full borrowed amount stays outstanding from the first month to the last, and comes due all at once at the end.
How the Payments Work
The mechanics are simple. You borrow a fixed amount, pay interest on it periodically, and hand back every dollar of principal when the loan matures. A $1 million bullet loan at 6% would require monthly payments of $5,000 for interest, but the balance would sit at $1 million throughout. On the maturity date, the full $1 million is due.
A less common variant requires no payments at all during the term. Interest accrues and compounds, and at maturity the borrower owes the original principal plus every dollar of accumulated interest. This structure concentrates repayment risk even more heavily, because the amount due at the end is larger than the amount borrowed.
Terms typically run from a few months to about ten years. The loan agreement fixes the interest-only period, the maturity date, and whether the rate is fixed or floating. Because principal never moves during the term, a fixed-rate bullet loan produces identical payments every period, which makes cash-flow planning straightforward.
How It Differs From an Amortizing Loan
A standard amortizing loan splits each payment between interest and principal. Early payments are mostly interest, but some principal comes off the balance every month. Over the life of the loan, the split gradually shifts until the balance reaches zero. A typical 30-year mortgage works this way.
A bullet loan skips the principal-reduction piece entirely. After five years of payments on a $500,000 bullet loan, you still owe $500,000. That has a direct effect on loan-to-value ratio: with an amortizing loan, LTV drops as you pay down principal even if the property doesn’t appreciate; with a bullet loan, LTV only improves if the asset gains value.
Bullet loans carry higher interest rates than comparable amortizing loans. Lenders charge a premium because the full principal stays at risk for the entire term, with no gradual paydown as a cushion. Commercial bridge loans with bullet structures commonly run in the 8% to 12% range, well above conventional amortizing commercial mortgage rates. The tradeoff for the borrower is much lower monthly outlays during the term, since no payment includes principal.
Bullet Loan vs. Balloon Loan
In casual conversation, people use these terms interchangeably. The structures aren’t identical, though. A true bullet loan is interest-only followed by a lump-sum principal repayment. A balloon loan may include some principal amortization during the term, just not enough to fully retire the debt. Payments are calculated as if the loan amortized over 20 or 30 years, but the loan actually matures much sooner, leaving a sizeable remaining balance.
The practical difference: on a balloon loan, the final payment is large but smaller than the original loan amount, because some principal has already come off. On a bullet loan, the final payment equals the entire original balance. Federal consumer protection rules use the broader term “balloon payment” to describe any final payment more than twice the size of a regular periodic payment.
Where Bullet Loans Are Used
Bullet loans live almost entirely in commercial and institutional lending. You won’t find one at a retail bank branch. The borrowers who use them have a specific, time-bound reason for the structure.
- Bridge financing: A developer acquiring a property before permanent financing is arranged might take a 12- to 24-month bullet loan to close the gap, with the plan to refinance or sell before maturity.
- Commercial real estate: Investors buying properties to renovate and resell within a few years often prefer bullet structures. Interest-only payments maximize cash flow during the holding period, and the sale is expected to fund the principal.
- Corporate finance: Companies sometimes use bullet loans to fund acquisitions or large capital expenditures when a future liquidity event, such as an equity raise or asset sale, is expected to generate the cash to repay.
- Bond markets: Most corporate bonds function as bullet instruments. The issuer pays periodic coupons and returns the face value at maturity. The structure is so standard in bond markets that it’s called a “straight” or “plain vanilla” bond.
What Lenders Evaluate
Approval for a bullet loan requires passing stricter underwriting than a conventional amortizing loan, because the lender’s full principal stays exposed for the entire term. Two metrics dominate.
The debt service coverage ratio (DSCR) measures whether the property or business generates enough income to cover the loan payments. Most lenders want a DSCR of at least 1.20 to 1.25, meaning income exceeds debt service by 20% to 25%. For riskier assets like office or retail, the threshold often rises to 1.30 or higher. Bridge loans with bullet structures may require 1.35 to 1.50 because of the added repayment risk.
The loan-to-value ratio caps how much the lender will advance against the appraised value. Strong, stabilized assets may qualify for LTVs of 65% to 75%; challenged property types or uncertain markets often push the ceiling down to 55% to 65%. A higher DSCR can earn a higher LTV, while a weak DSCR forces the lender to reduce its exposure.
Lenders also scrutinize the exit strategy. Vague plans don’t get funded. The lender wants a credible path to repayment: a signed purchase contract, a refinancing commitment letter, or documented cash reserves.
The Risk at Maturity
The central danger of a bullet loan is straightforward. Maturity day arrives and the borrower can’t pay. This is called a maturity default, and it happens more often than borrowers expect when market conditions shift between origination and maturity. Interest rates may have risen, making refinancing more expensive or impossible at the original leverage. The property may have lost value. Credit markets may have tightened.
When a borrower can’t meet the bullet payment, the situation usually resolves in one of three ways. The lender may agree to a short-term extension, typically six months or so, but will charge a fee, raise the rate, and often require additional equity. The borrower may negotiate a discounted payoff, where the lender accepts less than the full balance for immediate cash, which requires the borrower to have capital available. Or the lender forecloses or accepts a deed in lieu, taking control of the property. None of these outcomes is painless.
Planning an Exit Strategy
Every bullet loan needs a primary exit strategy and at least one backup. Three approaches are most common.
Refinancing is the most frequent exit. The borrower replaces the bullet loan with new financing, often transitioning to a standard amortizing structure. Underwriting, appraisals, and closing procedures for commercial loans can stretch across several months, so starting six to twelve months before maturity is common practice.
An asset sale is the cleanest exit when the business plan calls for it. Sale proceeds pay off the principal. The risk is that the sale may not close on schedule or the market price may drop below the loan balance. Aligning the maturity date with a realistic sale timeline is critical, and the ability to extend a few months adds a useful buffer.
Cash reserves work when the borrower has accumulated enough capital from operations or other sources. This is the most reliable exit and the least common for large commercial loans, since few borrowers can set aside the full principal during a short term. It’s more realistic for smaller bullet loans or borrowers with substantial existing liquidity.
Prepayment Penalties
Paying off a bullet loan early isn’t always free. Many commercial bullet loans include prepayment penalties designed to protect the lender’s expected interest income. Two structures dominate.
Yield maintenance requires the borrower to pay the remaining principal plus a penalty calculated to make the lender whole for the lost interest. The penalty is based on the difference between the loan’s rate and the current yield on a Treasury security with a similar remaining term. When rates have fallen since origination, this penalty can be substantial.
Defeasance takes a different route. Instead of paying off the loan, the borrower substitutes the real estate collateral with a portfolio of government bonds that generates enough cash flow to cover the remaining payments. The loan technically continues with a new borrower assuming it, but the original property is released from the lien. Defeasance is more complex and involves fees to multiple third parties, but it achieves the same result of freeing the property.
Yield maintenance is simpler and faster. Defeasance involves more parties and more paperwork. Either way, the cost of early repayment belongs in the deal economics before signing.
Tax Treatment
Interest paid on a bullet loan used for business purposes is generally deductible. Federal tax law allows a deduction for interest on business indebtedness, which includes commercial real estate loans and corporate borrowing. For larger businesses, the deduction is capped at the sum of business interest income plus 30% of adjusted taxable income for the year.1Office of the Law Revision Counsel. 26 USC 163 – Interest Small businesses meeting a gross receipts test are exempt from this cap, and electing real property businesses can also opt out of the limitation.
If a bullet loan is restructured at maturity and the lender forgives part of the principal, the forgiven amount is generally taxable as ordinary income. The IRS treats canceled debt as income in the year the cancellation occurs, and the borrower is responsible for reporting the correct amount regardless of whether the lender sends the proper tax form.2Internal Revenue Service. Topic No 431, Canceled Debt – Is It Taxable or Not Treatment differs by debt type. If a lender forecloses on property securing a recourse bullet loan, the borrower owes income tax on the difference between the forgiven debt and the property’s fair market value. With nonrecourse debt, where the lender’s only remedy is to take the property, there’s no cancellation-of-debt income.
These consequences can create an unpleasant surprise for borrowers who negotiate a discounted payoff or lose property to foreclosure. The IRS expects its share even when the borrower has lost money on the underlying deal.
A Note on Residential Balloon Mortgages
Bullet loans are predominantly commercial products, but balloon-payment mortgages do exist in the consumer market and are subject to federal regulation. Under the qualified mortgage rules that came out of the Dodd-Frank Act, a residential mortgage with a balloon payment generally cannot be a “qualified mortgage,” which means the lender loses certain legal protections against borrower lawsuits. Qualified mortgages cannot include balloon-payment features, interest-only periods, negative amortization, or terms exceeding 30 years. A narrow exception exists for small lenders operating in rural or underserved areas if the loan meets specific structural requirements.3Consumer Financial Protection Bureau. Ability to Repay and Qualified Mortgage Rule Small Entity Compliance Guide
When a consumer mortgage does include a balloon payment, federal disclosure rules require the lender to state that fact before closing, including the maximum balloon payment amount and when it’s due.4Consumer Financial Protection Bureau. Regulation Z 1026.37 – Content of Disclosures for Certain Mortgage Transactions If you’re being offered a mortgage with a balloon feature, those disclosures are the first line of defense. Read them carefully, and have a realistic plan for the lump-sum payment before signing.