Non-amortizing loans: overview, characteristics, and types

Afshan Qureshi
Afshan Qureshi
Content Marketing Manager
Posted on
May 26, 2022
min read
Non-amortizing loans: overview, characteristics, and types

When startups are ready to move beyond equity funding, they often assume that the next stage in the process is a bank loan. Many SaaS companies have struggled to obtain bank funding because they don’t have the traditional metrics a bank looks for in order to underwrite a loan (like physical assets). 

So what’s a SaaS startup to do? They can look to another round of equity funding, further diluting their share of the company, but that can be frustrating if there’s a real sense that the company is starting to grow.

Increasingly, founders in this growing industry of recurring revenue have looked to alternative methods of funding when they’ve been left with little options. Non-amortizing funding is an area of alternative financing that has been booming in recent years for that reason. While most people thinking of mortgages or cars when they hear words like non amortizing, there are finance options like this designed specifically for growing businesses as well.

What is amortization?

The term ‘amortization’ means to pay off, or kill off, over time. It’s traditionally used in financing to mean paying borrowed funds off over a set period and with a set amount, so that by the time the last agreed payment is made, the debt is paid off in full.

What is an amortized loan?

When most people think of a classic amortized loan, they are usually picturing a mortgage. An amount of money is loaned over an agreed-upon period of time, with set, regular payments made that represent both the principal sum borrowed and any interest due. It’s often the case that the earlier payments focus more on repaying the interest due, with the later payments being more focused, or entirely related, to repaying the principal.

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While there are variations in how an amortized loan can be used, the goal is always to make the final instalment due and have the entire loan paid off at the same point. Sometimes, a borrower will take a break in payments, for example, or even default on their schedule repayments. Some amortized loans include changing interest rates over time. No matter how these specifics change what is paid during the term of the loan, the goal of complete repayment after the last scheduled payment is still the same.

What is a non amortized loan?

The classic example of a non amortizing loan is a credit card. A non amortizing loan can also be structured in a number of ways, but the similarity for all of them is that the majority or all of the principal sum borrowed is paid off in a lump sum at the end of the agreed term.

A non amortizing mortgage, or home equity line of credit (HELOC) is another example of a well-known non amortized loan. It’s a line of credit that is secured by your home and while these are often used by homeowners in relation to home improvement projects, they can also be taken out by founders in relation to their company.

Types of non amortizing loans

There are a number of different ways that non amortized loans can be structured, depending on how long the loan will last and what terms suit the borrower and lender. The common ones are as follows:

Bullet loan

This is where all monies due - all principal and interest - are paid back at the end of the term and no payments are made in the interim.

Balloon loan

A balloon loan is a very common type of non-amortized loan. It involves interest and sometimes a small part of the principal loan being paid back with regular scheduled payments over the term, with the bulk of the principal loan being due at the end of the term.

Interest only loan

This is a type of balloon loan, where only the interest is paid in schedule payments over the term and the full principal is due at the end of the loan. This is a common structure for student loan repayments. It’s not uncommon for the repayment of the principal to be delayed further due to refinancing at the end of the loan term.

Deferred interest loan

With a deferred interest loan, if the principal is paid back within an agreed time period then no interest is due at all.

Revolving line of credit

This is a type of loan where the user can borrow up to the credit limit continuously through an agreed period, even after paying off all or some of the principal, without going through another loan approval process. A HELOC is a perfect example of this particular type of non amortized mortgage.

Benefits of a non amortized loan

Non amortizing loans can be a great choice for businesses who are in a growth period. They may not have cashflow available immediately and so want to keep their monthly repayments as low as possible. Non amortized loans can be a great part of your strategy as you assess how to use working capital during a period of growth. 

These types of loans can also be great during periods of market uncertainty, when a company is looking to minimize risks and reduce costs across the board.

For many businesses who struggle to obtain bank funding, non amortized loans can offer a financing alternative to venture capital, and often in a manner that doesn’t involve months of documentation and contracts.

Disadvantages of a non amortizing loan

While non amortized loans can provide a fantastic ‘third choice’ if founders don’t want to use venture capital and can’t obtain bank funding, there are some downsides.

Interest rates are often much higher than with traditional debt due to the higher risk that a lender takes on. If a startup uses a non amortized mortgage or loan on the assumption they are going to grow and be able to afford to pay the principal back at a future date, there’s always a risk inherent there that growth doesn’t go as expected, and they are in a position where they have to default on the loan at its term.

How SaaS companies can grow with alternative funding

For SaaS and tech enabled companies who often struggle to obtain traditional bank loans, non amortized loans can be a great option to allow for working capital without having to dilute the company any further.

If you have already used venture capital, non amortized loans can allow for you to extend the runway before you need to consider all the red tape and planning needed to raise another round of funding.

Founders should always be thinking about financial planning and making the most of the capital they ‌do have. Knowing about additional, flexible funding options is a great way to add value and open up potential options within your future financial plans.

If you want to learn more about alternative forms of financing, then check out the options available through Capchase. We love to support SaaS and tech-enabled businesses grow with non dilutive financing options.

Our Grow product is great for allowing you to inject capital at exactly the times you need it and scale investments without having to go through weeks of documentation every time you need another drawdown. Our Extend product is fantastic for recurring revenue companies who are looking for expense financing that scales at your pace.

If you want to know how much finance you could have available to you through Capchase, try out our capital calculator. By entering estimates of your key financial metrics, we can provide you with an estimate and show you how we can help you accelerate your growth today.