Bullet Transaction
A loan with 100% of the principal paid upon maturity, and interest-only payments during the life of the loan.
Steve wanted to buy his queen (and fiancée), Cathy, a McDonald’s franchise that cost $200,000. He didn’t have enough money, though, and knew that the location would need to sell a lot of burgers before he’d be able to repay the money he’d have to borrow.
Being a Shmoop grad, he also knew that once that breakeven point was reached, the free cash flow would scale quickly. In need of a means of financing that would buy him the time required to ramp up the business, he entered into a bullet transaction with a 5% interest rate over 10 years. At just $10,000 per year of interest, he was able to service the loan, put aside money to pay off the entire $200,000 balance in Year 10, and save money to buy himself a snazzy Ford Mustang. That's a whole lot o' chicken nuggets.
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Finance: What is Balloon Interest, or a ...198 Views
Finance a la shmoop what is balloon interest or a balloon payment. All right
people you blow and blow and blow and blow and then one day it pops. Well [Balloon with loan written on it explodes]
that's kind of what a balloon loan looks like in most cases common loans are paid [House with a sold sign]
down as they go like a home mortgage on you know your brand-new home there
Well it starts out as 400 grand payable over 30 years and then little by little
grinding away year after year after year the loan is paid down and the final [Years going by and the principal remaining reducing]
payment is like well just a few grand and you're the proud owner of a 30-year
old shack it's become one after 30 years... Well were this a balloon payment style [Picture of a wooden old house]
of loan well you might have just paid interest on that four hundred grand for
twenty nine point nine years and then that last payment would be the four
hundred grand principle you'd borrowed. Huge or as a famous real estate man once
said huge, that could be one month's interest on the four hundred grand plus [Donald Trump appears]
four hundred grand well that last balloon payment will have
popped when you've paid off your house. Well the same structure of debt lives in [Guy pops the balloon with a pin]
the world of zero coupon bonds and t-bills as well where you as an investor
buy a notional par value of say a grand, at a discount meaning you're buying that
thousand dollars at a discount... meaning you pay six hundred forty-two
bucks for a payment of a thousand dollars in six years with no payments of
interest or pay down of principal in between. That final loan payoff is the [Hot air balloons in the background]
balloon oh happy day and it isn't even your birthday [Guy in a suit dancing with balloons and confetti falling]
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