What it means
Most everyday loans amortise, meaning each payment includes some interest and some repayment of the principal, so the balance shrinks over time. A non-amortising loan does the opposite.
The balance stays the same through the life of the loan, and the borrower pays only the interest due. The main forms are interest-only loans and bullet loans.
With an interest-only loan, the borrower pays interest each month and the entire principal is due at the end. With a bullet loan or bond, the borrower may pay interest periodically, or sometimes accrue it, and then settle the full amount on a single maturity date.
Businesses like these structures because they keep cash outflows low while a project matures. A company building a factory or a property developer waiting for sales to complete might accept interest-only payments rather than strain its cash flow.
Many corporate bonds are also non-amortising, which suits investors who want predictable interest and the return of their full principal on a known date. The risk sits at the end.
The borrower must find the whole principal on one day, either from savings, from selling an asset or by refinancing (replacing the old loan with a new one). If credit markets have tightened or the asset has lost value, that final payment can be hard to meet, which is called refinancing risk.
Lenders manage this by asking for security, charging a higher interest rate or setting conditions such as a maximum loan-to-value ratio. Borrowers can reduce the risk by setting aside money in a sinking fund (a reserve built up gradually to repay the debt).
Both sides should understand that the lower early payments do not make the loan cheaper overall. In comparison, an amortising loan costs less in total interest, because the balance on which interest is charged falls each period.
The choice depends on whether lower payments now are worth the extra cost and risk later. Managers should compare the two with the same assumptions before deciding.
In practice
Real-world examples.
Example
A property developer borrows $4,000,000 on an interest-only basis while it builds an apartment block. It pays only interest during construction and plans to repay the principal from sales. The lower payments protect its cash during the build.
Example
A manufacturing company issues a ten-year bond for $20,000,000 that pays interest twice a year and repays the whole amount at maturity. Investors receive a steady income and know exactly when the principal comes back. The company sets aside money each year to prepare for the final payment.
Example
A landlord takes an interest-only loan on a rental building, expecting rents to cover the interest. When the loan matures after seven years, the building's value has risen and she refinances into a new loan. If values had fallen, she would have struggled to find a lender.
Formula
Calculation
Annual interest = principal x annual interest rate
A company borrows $500,000 on a non-amortising basis for 5 years at 6%. Annual interest = 500,000 x 0.06 = $30,000, so total interest over 5 years = 30,000 x 5 = $150,000. At the end of year 5 the company must also repay the full $500,000 principal, giving a total cash cost of 500,000 + 150,000 = $650,000.Case study
Seen in the real world.
Maplecrest Developments is a fictional company that borrowed $6,000,000 on a non-amortising basis for a retail centre, at an interest rate of 7%. In this illustrative story, annual interest was 6,000,000 x 0.07 = $420,000, which the centre's rents covered comfortably. The loan was due in full after five years.
When the loan matured, credit conditions had tightened and lenders offered only 60% of the centre's value, equal to $5,400,000. Maplecrest had to find the missing $600,000 from its own funds and sold another property to do so. The finance director has since set up a sinking fund for every non-amortising loan and refinances at least eighteen months before maturity.
Watch out
Common mistakes.
- Focusing only on the low monthly payment. The full principal remains owing and must be repaid at the end.
- Assuming the asset's value will always cover the loan. If values fall, refinancing can become difficult or impossible.
- Believing a non-amortising loan costs less. It usually costs more in total interest than an amortising loan of the same size and rate.
Questions
People also ask.
What is the difference between amortising and non-amortising loans?
An amortising loan repays principal gradually, while a non-amortising loan leaves the principal to be repaid at maturity.
Are bonds non-amortising?
Most standard corporate and government bonds are, paying interest regularly and returning principal at maturity.
How can a borrower prepare for the final payment?
By building a sinking fund, planning an asset sale or arranging refinancing well before the due date.
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