What does the term “Bullet” mean in the world of investments?
Did you know that there is a loan called bullet? It is called such because it is somehow similar to how a real bullet works. When a person, typically the borrower, repays the creditor all the outstanding loan amounts at once. It is a lump sum. Hence, it is like how a bullet from a fired gun fatally eliminates anything or anyone it passes through. It describes a loan that should be repaid at maturity all at once or at a significant portion. Some companies or governments say the term “bullet” when discussing an investment strategy that issues bonds with different types and lengths of maturity.
How does the bullet loan work?
Bullet loans give borrowers quite a variety of options. If you are unfamiliar with the term, it is similar to a balloon loan or balloon payment. This loan needs the borrower to agree that they should pay the whole amount of the principal at maturity. Borrowers have at least two choices on how they can make this possible:
- They can choose not to pay at all during the life of the loan. However, they will pay the total amount at maturity.
- They can opt to pay interest-only payments to reduce the lump-sum amount they have to pay at maturity.
Bullets, borrowers, and financial situations
Creditors and borrowers may agree with a provision built in the loan upon its issue. This helps borrowers pay lump-sum repayments all at once. It is, of course, upon the discretion of the borrower. Some find this useful because they do not have to worry about any payments during the life of the loan. This is a relief for borrowers, most especially if their finances get better later after the issuance. In some instances, if a borrower takes an early lump-sum repayment, there are chances that the interest expense accumulated throughout the life of the loan will be less. However, some would instead choose to pay those interest rates little by little, so they can at least lessen the considerable lump sum they have to pay at the maturity date.
Bullets and amortizing loans
We are sure you have heard of these terms. Banks have a lot of these options. The bullet and amortizing loans have different interests and modes of payments. Let us start with amortizing loans. Here, the borrowers pay both the interest and principal little by little, regularly and on schedule. At maturity, all of the debt has already been paid.
On the other hand, bullet loans allow borrowers to make interest-only payments or no payments at all, at least until maturity. The only time that this loan asks the borrower to pay everything, or the remaining debt amount, is at maturity.
Borrowers might find monthly payments on amortizing loans more. However, if we calculate the interest accrued, we will find that it is considerably lower than what you will accrue with a bullet loan.
Is the bullet also applicable to bonds?
Bullets on bonds work the same way as what we just explained. It is a debt instrument where the borrower should pay the total outstanding debt at maturity. However, the issuer cannot redeem these bonds prematurely because they are non-callable. The issuer’s interest rate exposure makes the interest rates of bullet bonds significantly lower. While people consider bonds safe investments, bullet bonds are riskier than amortizing bonds since the issuer should pay a massive amount all at once compared to paying little by little until there is no more debt.
