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There are approximately 5 million Hispanic- and Latine-owned owned businesses in the U.S. And those businesses are booming, according to a recent survey of 1,000 Hispanic and Latine business owners in the U.S. In fact, more than two-thirds of survey respondents report that their companies are doing the same or even better than they did before the pandemic.

Some business owners were able to turn the challenging lockdown period into an opportunity: One-third of respondents cited Covid-19 as the motivation for launching their companies.

Even as Hispanic- and Latine-owned businesses thrive, however, respondents report that some roadblocks remain. For instance, half of the Hispanic business owners surveyed say they face prejudice from their customers and from other business owners. Some 40% need a second job in order to make ends meet. Yet despite the obstacles, Hispanic business owners say they would encourage their peers to pursue their entrepreneurial dreams.

How do Hispanic- and Latine-owned businesses flourish even in tough times? Read on to learn the success strategies survey respondents shared with us.

Source: Based on a survey conducted on August 2, 2023, of 1,000 Hispanic and Latine business owners in the U.S. ages 18 and older.

Percentages have been rounded to the nearest whole number, so some data may not add up to 100%.

Who Is the Boss?

Of the Hispanic and Latine business owners who participated in our survey:

•   60% are female and 40% are male

•   62% founded or started their business

•   56% are sole proprietors, while 44% have at least one partner

Peak Performance

Despite difficulties posed by the pandemic, Latine- and Hispanic-owned businesses are thriving. Seventy-two percent of survey respondents say their business is doing the same or even better than it did before Covid.

Type of Businesses They Own

•   Retail: 22%

•   Service:17%

•   Other: 12%

•   Manufacturing: 11%

•   Restaurant/food service: 7%

•   Subscription business: 6%

•   Affiliate (earn commission when a member of their audience buys a product or service they recommend): 6%

•   Franchise/franchisee: 5%

•   Product as service: (a laundromat, for example): 4%

•   Distribution: 4%

•   Leasing/renting: (such as construction equipment leasing): 3%

•   Brokerage: (connecting buyers and sellers): 3%

Seizing the Opportunity

While some companies shuttered during Covid, a significant number of Hispanic- and Latine-owned businesses launched during that time. In fact, one-third of the Hispanic and Latine business owners surveyed started a business during or after the pandemic.

For some of the one-third of respondents who chose this answer it was a necessity: 30% took the plunge because they could no longer pay their bills and needed a source of income. But for just as many, pursuing a dream was the driving factor. Thirty percent said they launched their companies because they “realized life is short and decided to pursue a passion.”

Of Hispanic and Latine business owners with household incomes above $125,000, 36% said the pandemic gave them additional resources to work with, such as stimulus checks and more time to devote to their startups.

Pain Points

Hispanic- and Latine-owned businesses do face some challenges, however, including:

Inflation Is a Major Concern

The high cost of supplies due to inflation poses the biggest threat to the growth of their business, 54% of respondents say. This was almost double the second greatest obstacle — difficulty hiring qualified employees.

Factors Affecting Business Growth

•   High cost of supplies due to inflation: 54%

•   Difficulty hiring qualified employees: 28%

•   Banks’ reluctance to approve loans: 26%

•   Decline in brick-and-mortar business in favor of the internet: 25%

•   Supply chain issues: 25%

Good Funding Is Hard to Find

Securing the capital to start a business is often difficult for Hispanic and Latine business owners, according to a recent report from the Stanford Graduate School of Business. Almost half (49%) of the Lantern survey respondents said they used their personal savings to help start or acquire their businesses. And 29% used family savings to help get their business off the ground.

Household income determines how Latine- and Hispanic-owned businesses are funded, our survey found. Respondents with household incomes less than $50,000 were much more likely to use personal savings than those whose household incomes were more than $125,000. Some of the higher earners secured home-equity loans or small business loans. Those with lower household incomes did not and instead resorted to personal credit cards and personal assets other than savings.

Where the Startup Money Came From

Those with household incomes under $50,000 used:

•   Personal savings: 56%

•   Family savings: 25%

•   Personal credit cards:11%

•   Personal assets other than savings: 8%

Those with household incomes over $125,000 used:

•   Personal savings: 36%

•   Family savings: 31%

•   Home equity loan: 20%

•   Business loan from a financial institution: 13%

•   Business credit cards: 12%

If you’re thinking about opening a business and looking for startup money, there are small business grants available. Explore the options to find out if you qualify.

They Need Another Job to Make Ends Meet

For a significant number of survey respondents, owning a business doesn’t generate enough income — almost 40% have a second job. That includes 44% of Hispanic and Latine business owners who are 24 and younger.

Prejudice Is Still Prevalent

Half of Hispanic and Latine business owners say they’ve experienced prejudice from customers, business acquaintances, or vendors because of their heritage. Of those, 39% experience it at least quarterly.

Those most likely to face prejudice are younger and work in the food business:

•   67% of business owners 24 and under have experienced prejudice

•   62% of restaurant/food service business owners say they’ve faced prejudice

The Trickiest Part of Being the Boss

Work/life balance is the toughest part of owning a company, according to 34% of Hispanic and Latine business owners. Women were the most likely to struggle with this — 60% of respondents who chose this answer were women. Other issues Hispanic and Latine business owners wrestle with:

•   Becoming and staying profitable: 32%

•   Scaling their business for growth: 27%

•   Managing cash flow: 25%

•   Assessing and taking risks: 24%

Recommended: Starting a Small Business

The Family Business

Many Hispanic and Latine business owners keep it all in the family by employing relatives, especially siblings — 41% said they brought a brother or sister onboard. And of the 44% of respondents who own their business with at least one other person, 31% co-own with a sibling.

Other family members they’re most likely to employ:

•   Cousin: 27%

•   Parent: 23%

•   Aunt/uncle: 15%

•   Grandparent: 13%

Social Media Makes a Difference

Promoting their business was the most challenging aspect of starting it, survey respondents report. So how do they get the word out? Most Hispanic and Latine business owners (57%) say they use social media to publicize their business. Thirty-seven percent have a website, and 31% rely on listings on online marketplaces to help draw customers in.

Paying It Forward

Supporting their community, culture, and heritage is a priority for Hispanic and Latine business owners. As a bonus, doing good work often allows them to promote their companies at the same time.

How they give back:

•   34% encourage other businesses to work with Hispanic and Latine businesses and communities

•   33% try to educate their customers and the public about Hispanic and Latine heritage

•   33% sponsor or participate in Hispanic and Latine community events or groups

•   29% contribute to Hispanic and Latine programs or causes

•   22% seek out other Hispanic- and Latine-owned businesses to work with

Their Best Business Advice

Despite the challenges they may face as business owners, survey respondents encourage others to pursue entrepreneurship. These are the words of wisdom they would pass along to those hoping to start Hispanic- and Latine-owned businesses.

Rise above prejudice and racism:

“Don’t be afraid and don’t let racism discourage you.”
“If you can, go for it. You will face racism, but don’t let that deter you from chasing your dreams.”

Be proud of your heritage and promote it:

“Admire your heritage, no matter what people say. Be proud of what you do and who you are.”
“Embrace your cultural heritage and leverage it as a unique selling point in your business.”
“Do what you love and express your culture.”

Recommended: Grants for Minority Owned Businesses

The Takeaway

Despite some challenges, many Hispanic- and Latine-owned businesses are flourishing post-pandemic. Most are doing the same or even better than they did before Covid-19, according to our survey. Hispanic and Latine business owners take great pride in their heritage, and they use their businesses to give back to their communities and raise awareness of their culture.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

Photo credit: iStock/FG Trade Latin

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

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While both insolvency and bankruptcy describe a situation where a person or company is unable to pay their debts, bankruptcy is a legal declaration – it’s what can happen if insolvency doesn’t get resolved.

Keep reading for a closer look at bankruptcy vs insolvency, how each situation can happen to a person or small business, and the pros and cons of formally filing for bankruptcy.

What Is Bankruptcy?

Bankruptcy is a legal lifeline that an individual or company can use when they are unable to pay their debts. Debtor’s file for bankruptcy through the federal court system, and in return they receive aid in discharging their debts or making a plan to repay them. Individuals, couples, corporations, and small businesses can file for bankruptcy.

Bankruptcy is designed to give individuals and businesses who are unable to pay their debts a fresh start, while also giving creditors a chance to recoup at least some of what they are owed when a debtor’s assets are liquidated.

Bankruptcy can have a big effect on a debtor’s financial record, particularly their credit scores. Businesses that file for bankruptcy may have difficulty getting approved for many types of business loans during the period that the bankruptcy remains on their credit reports.

Recommended: Free Credit Score Monitoring

How Does Bankruptcy Work?

Before a debtor can file for bankruptcy, there are a few requirements they need to meet. First, they need to demonstrate that they can’t repay their debts, as the courts can choose to toss out bankruptcy cases when they believe an individual has enough assets to cover their debts. They also need to get credit counseling with a government-approved credit counselor, who can help them assess their assets and determine if there are better alternatives to bankruptcy.

If, after receiving counseling, the debtor moves forward with their bankruptcy case, they’ll need to decide what type of bankruptcy to file.

Bankruptcy provides an automatic stay of collections and immediate relief from creditors who must stop collections proceedings while your case is active. The courts will look at the debtor’s assets and decide how much they can reasonably pay and which debts they don’t have to pay.

Types of Bankruptcy

The three main types of bankruptcy for individuals and businesses are Chapter 7, Chapter 11, and Chapter 13.

Chapter 7 Bankruptcy

Also known as “straight bankruptcy” or “liquidation bankruptcy,” Chapter 7 bankruptcy is the most common type of bankruptcy. It entails the selling or “liquidating” of an individual or business’s assets to distribute to creditors. Certain assets are exempt from this sale, however, such as cars needed for transportation, basic household furnishings, and the tools needed for work.

Once the assets are liquidated and the debtor has given what money they can to their creditors, the rest of their debt is discharged. However, there are a few exceptions — an individual is still on the hook for child support, court-ordered alimony, taxes, and student loans.

A Chapter 7 bankruptcy will stay on the debtor’s credit report for 10 years after the filing date. And if that person/business gets in over their head again, they won’t be able to file for this chapter for another eight years.

Chapter 11 Bankruptcy

Chapter 11 bankruptcy is designed to help struggling businesses restructure their finances so they can remain open. With this type of bankruptcy, a debtor is able to remain in control of their business and renegotiate the terms of their debts with creditors, such as modifying interest, payment due dates, and other terms. It can sometimes even erase debt entirely.

Chapter 11 bankruptcy allows a business to stay intact and come out the other side as a healthy business. However, it can be the most complex of all the bankruptcy chapters. It also tends to be the most expensive type of bankruptcy proceeding.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy may be an option for individuals or business owners who have a regular income stream. It allows the debtor to keep their property and develop a new payment plan to pay back either part or all of their outstanding debts over three to five years. A Chapter 13 bankruptcy stays on an individual’s or business’s credit report for seven years, and those who find themselves swamped by debt yet again can file for this chapter after just two years.

Recommended: What to Know About Short-Term Business Loans

What Is Insolvency?

Insolvency is when an individual or business is unable to pay outstanding debts to creditors or banks due to lack of funds. A person or company can be insolvent without going bankrupt. However, if they are bankrupt, they are, by definition, insolvent.

Insolvent individuals and businesses have options to help them pay back their debt. They could borrow money, increase income, or negotiate repayment with creditors. If these options fail, bankruptcy may be the only remaining possibility.

Recommended: Types of Business Loans

How Does Insolvency Work?

There are two different types of insolvency: Cash flow insolvency and balance sheet insolvency. Cash flow insolvency, or illiquidity, occurs when an individual doesn’t have the money to pay off their debts. Balance sheet insolvency occurs when total debts exceed the value of total assets.

A business could be cash flow insolvent while being balance sheet solvent if they have assets they could sell that are worth more than their debt. The reverse is also possible: A business can be balance sheet insolvent (debts exceed assets), but cash flow solvent if it’s able to meet its immediate financial obligations. In fact, many businesses operate this way.

When an insolvent individual or business is unable to meet their debt obligations, creditors will begin efforts to collect their due. At this point, insolvency can become a real problem.

For example, if an individual holds secured debt, such as a mortgage, the lender may start foreclosure proceedings on their home. If these go through, the individuals will lose their home, and the bank will sell it to help recoup the debt. For unsecured debt, such as credit cards or personal loans, lenders may send the debt to a collections agency, which may then hound the individual in an effort to get them to pay.

Insolvency vs Bankruptcy

Insolvency and bankruptcy are not the same thing, but they are very much related. Here’s a quick look at the similarities and differences between the two terms.

Similarities

The main characteristic that insolvency and bankruptcy share is the inability to pay off debts. This may mean that an individual or business does not have the cash to pay them off or enough assets to liquidate to cover the debt.

Bankruptcy can damage a person’s or business’s credit score for up to 10 years, making it more difficult for a filer to acquire credit in the medium-term. Insolvency can also damage a debtor’s credit if they are unable to pay their bills on time (though not nearly as much as bankruptcy). A delinquent payment will remain on a person’s or business’s credit report for seven years. While bankruptcy is much more damaging, both insolvency and bankruptcy can hurt your chances of approval when applying for a small business loan.

Differences

The main difference between insolvency and bankruptcy is that insolvency is a state of being, whereas bankruptcy is a legal designation. Someone who is insolvent has not necessarily filed for bankruptcy, as there may be other tactics they can use to pay down their debt. Insolvency can often be reversed by negotiating with creditors or with an infusion of cash, such as an inheritance, bonus at work, or large business payment.

Someone who has filed for bankruptcy has determined that they have no other options to pay off their debt. The court will then determine if they have any assets that they can sell. Proceeds from the sale are given to creditors, and debts are discharged.

Here’s a look at bankruptcy vs insolvency at a glance:

Pros and Cons of Filing for Bankruptcy

Bankruptcy can be a solution to insolvency, but it comes with a number of downsides. Here’s a look at the pros and cons.

Recommended: What Is a Small Business Audit?

Pros of Filing for Bankruptcy

•   Stay of collections and repossessions: When you file for bankruptcy, there is an automatic stay of collections. Creditors must hit the pause button on collecting debt, repossessing property, garnishing wages, filing lawsuits, and making phone calls.

•   Debt relief: Your creditors will likely be forced to accept whatever payment is determined in your bankruptcy case, including no payment. You may be able to discharge most of your unsecured debt, including credit cards, personal loans, and medical bills.

•   A chance to start over: Once bankruptcy proceedings are over, an individual or business can begin to rebuild their finances and reestablish good credit.

Cons of Filing Bankruptcy

•   Your credit score will take a hit: A Chapter 7 bankruptcy will remain on your credit report for 10 years, while a Chapter 13 bankruptcy stays on your report for seven years. During that time, it will likely be much harder to secure new lines of credit, as lenders may see the bankruptcy filing as a red flag.

•   Some debts may remain: While you may be able to discharge most unsecured debt, other debt can’t be wiped out. You must still pay child support and alimony, tax liens, and student loans.

•   You could lose assets of value: Depending on which type of bankruptcy you qualify for, your income, and how much equity you have in your assets, you could lose personal or business items of value that must be sold off to pay creditors.

Here’s a look at the pros and cons of filing for Chapter 7 bankruptcy at a glance:

Recommended: Debt Convenants Explained

The Takeaway

Though people may say they are “bankrupt” when they are too broke to pay off their debts and obligations, it’s not actually the correct word. The right term is insolvent. In order to be bankrupt, the person must first file a petition with the court declaring their bankruptcy.

Insolvency that can’t be solved results in bankruptcy. And, while filing for bankruptcy comes with a host of cons, it also provides a chance to make a fresh start, rebuild your credit, and once again have an opportunity to take out loans and lines of credit for yourself or your business.

Options for getting out of debt include budgeting and saving so you can more easily tackle your debts, filing for bankruptcy, or taking out a small business loan to consolidate your debts and possibly pay them off faster.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

What do you lose if you have to declare bankruptcy?

When you declare bankruptcy, you may have to sell certain assets to help settle debts with creditors. And, the bankruptcy will be a negative mark on your credit report for seven years when filing Chapter 13 bankruptcy or 10 years when filing Chapter 7 bankruptcy.

How much debt do you need to be in to file for bankruptcy?

Federal bankruptcy law doesn’t specify any minimum debt amount to file a bankruptcy case. However, you must prove that the value of your assets is less than the amount of debt you owe.

What does financially insolvent mean?

Individuals who are financially insolvent either do not have the cash flow to cover their debts or the total value of their assets is less than their total debt. Insolvency does not automatically mean someone is bankrupt.

Photo credit: iStock/golubovy

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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A debt instrument is a contract that enables one party to loan funds to another party, who promises to repay the loan plus interest. Debt instruments are also referred to as fixed-income assets because the lender receives a fixed amount of interest during the lifetime of the instrument.

Debt instruments come in many forms. Some are obvious, such as mortgages and different types of small business loans; while others are less so, such as rental leases, bonds, and treasuries. With some debt instruments, you are the borrower (such as when you take out a mortgage or credit card). In other cases, you are the lender, such as when you purchase a bond or treasury.

Here’s what you need to know about debt instruments, the different types of debt instruments, how these instruments work, and the pros and cons of debt financing.

What Are Debt Instruments?

A debt instrument is a fixed income asset that legally binds a debtor to pay back any amount borrowed plus interest. Debt instruments can be issued by individuals, businesses, local and state governments, and the U.S. government.

Businesses often use debt instruments to raise capital to purchase additional assets (such as manufacturing equipment) or to raise working capital, while local governments may do so to fund the building of infrastructure (such as a new highway or a bridge). Debt instruments also give participants the option to transfer the ownership of debt obligation (or instrument) from one party to another.

Debt instruments can be short-term (repaid within a year) or long-term (paid over a year or more). Credit cards and treasury notes are examples of short-term debt instruments, while long-term business loans and mortgages fall into the category of long-term debt instruments.

Recommended: What to Know About Short-Term Business Loans

How Do Debt Instruments Work?

If you’ve ever taken out a loan or credit card, you probably already understand the basics of how debt instruments work. Debt instrument contracts include detailed provisions on the deal, including collateral involved, the rate of interest, the schedule for interest payments, and the term of the loan (or timeframe to maturity).

While any type of vehicle classified as debt can be considered a debt instrument, the term is most often applied to debt capital raised by institutions, such as companies and governments. In this scenario, the investor is the lender: You issue money to a business, municipality, or the U.S. government. In exchange for capital, you are paid back the amount you loaned over time with interest. Examples of this type of debt instrument include U.S. treasuries, municipal bonds, and corporate bonds.

Recommended: Lease or Purchase Equipment

Types of Debt Instruments

Below is a breakdown of some of the most common debt instruments used by individuals, governments, and companies to raise capital.

US Treasuries

U.S. Treasury securities (also called treasuries) are government debt instruments issued by the U.S. Department of the Treasury to finance government spending as an alternative to taxation. Treasury securities are backed by the full faith and credit of the U.S., meaning that the government promises to raise money by any legally available means to repay them.

U.S. treasuries tend to be more affordable than many other debt instruments. Investors can buy them in increments of $100 either through brokerage firms, banks, or the U.S. Treasury website. There are three types of treasuries: treasury bills, treasury notes, and treasury bonds. Each treasury comes with its own maturity option.

Municipal Bonds

Municipal bonds are offered by various U.S. government agencies (towns, cities, counties, or states) to fund current and future expenditures. Programs often funded by municipal bonds include the building of schools, roads, and bridges. Think of a municipal bond as a loan an investor makes to a local government.

There are two types of municipal bonds: general obligation bonds and revenue bonds. General obligation bonds are not paid back by any revenue resulting from the completion of the project. Instead, they are paid back to investors through property taxes or overall general funds.

Revenue bonds are paid back by the issuer through either sales, taxes, or some other type of revenue generated by the project.

Municipal bonds are attractive to many investors because they are tax exempt bonds — meaning the investor doesn’t have to pay taxes on any interest received.

Corporate Bonds

A corporate bond is a debt security that a corporation can use to raise money. Funding is typically available to anyone who is interested. As with other bonds, corporate bonds are essentially an IOU from the company to the investor. It differs from stock in that, instead of being paid dividends when the company is profitable, investors are always paid regardless of whether the company is doing well.

Typically, corporate bond investors are paid interest until the bond matures. When it matures, the entire principal is paid back. For example, a $1,000 corporate bond with an interest rate (or coupon rate) of 5%, would bring an investor $50 every year until the bond matures. This means that, after 10 years, the investor would see a gross return of $500.

With secured bonds, the company puts up collateral (such as property or equipment) as security for the bond. If the company defaults, secured bond holders can foreclose on the collateral to reclaim their money. With an unsecured bond, a holder may or may not be able to fully reclaim their investment.

Alternative Structured Debt Security Products

There are many types of structured debt security products on the market, many of which are issued by financial institutions. A common occurrence is for these institutions to bundle assets together as a single debt security product. By doing this, they are able to raise capital for the financial institution while also segregating the bundled assets.

Recommended: Single and Multi Step Income Statements

Leases

A residential or commercial lease is a legally binding contract between an owner of a property and a tenant where the tenant agrees to pay money for a set period of time in exchange for use of the rented property. A lease is a type of debt instrument because it secures a regular payment from the tenant, thus creating a secured long-term debt.

Mortgages

Mortgages are a type of debt instrument used to purchase either a home, commercial property, or vacant land. The loan is secured by the property being purchased (which the lender can seize if the borrower defaults on the loan).

As with many other consumer loan products, mortgages are amortized, meaning the borrower makes a series of equal monthly payments that provides the lender with an interest payment (based on the unpaid principal balance as of the beginning of the month) and a principal payment that will cause the unpaid principal balance to decrease each month so that the principal balance will be zero at the time of the final payment.

When seeking a mortgage, it’s important to shop around and compare mortgage rates. While most lenders base their rates on the going prime rate, some are cheaper to work with than others because of additional costs such as origination and processing fees.

Recommended: Mezzanine Financing

Pros and Cons of Debt Instruments

Debt instruments can be mutually beneficial in that both parties become better off as a result. If a company takes out a small business loan and invests those funds wisely, for example, it can increase its profitability. Ideally, the increase in profits exceeds the cost of the loan, a concept known as leveraging in business. Borrowing money also allows a company to raise capital without losing equity.

Debt instruments also benefit individuals and governments. Without mortgage debt, many people would never be able to buy a house or afford to go to college because of the cost. For governments, debt instruments allow them to build infrastructure for the public good.

On the lender’s or investor’s side, debt instruments can provide a regular and guaranteed source of income and are considered a safe investment, provided the loan is secured.

But there are downsides to debt instruments, as well. Loans often come with restrictions on how they can be used and, if you don’t have good credit, interest rates can be high. Borrowing money also involves risk. Most commercial institutions will require you to put up collateral in the form of a property asset. If you lose your income or your business hits hard times and you cannot repay your loan, the lender can reclaim its debt by liquidating whatever you proposed as security, which means you can lose a valuable asset.

On the lender’s or investor’s side, debt instruments also come with risk. Unless you purchase a secured bond, you may not receive your principal back as the investor. Also, during periods of high inflation, bonds can actually have a negative rate of return. And, if you invest in corporate bonds, there is always the possibility that the issuer will default on payment.

The Takeaway

A debt instrument is a way for an investor to get a return on their money by loaning to either an individual, business, municipality, or the U.S. government. If you have a credit card or mortgage, or you own any bonds or treasuries in your investment portfolio, debt instruments play a role in your life.

Small business owners can also take advantage of debt instruments. You might not be able to issue corporate bonds at this stage of the game, but you may be able to access an affordable small business loan.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

What are some examples of debt instruments?

Common examples of debt instruments include: personal loans, business loans, mortgages, leases, bonds, treasuries, promissory notes, and debentures.

What is the difference between a debt instrument and an equity?

With a debt instrument, the investor does not own any portion of the company. With equity, the investor is buying a portion of the company.

What are the features of debt instruments?

Debt instruments have three characteristics: principal, coupon rate, and maturity. Principal refers to the amount that is borrowed. The coupon rate is the interest amount paid by the borrower to the lender. Maturity is the end date of the debt instrument. It refers to when the debt is completely paid off with interest.

Photo credit: iStock/insta_photos

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOSB0424050

A balloon payment is a payoff option on a loan that allows you to make a larger-than-usual lump sum payment at the end of the loan’s term. This, in turn, can lower your earlier payments.

A balloon payment structure is sometimes offered on home mortgages, auto loans, and business loans. Is it a good deal for the borrower? Sometimes. However, balloon loans also come with some significant risks.

Read on for a closer look at how balloon loans work, when you might consider getting one, and alternative ways to reduce your loan payments.

What Is a Balloon Payment?

A balloon payment is just like its name suggests – it balloons, or inflates, at the end of the loan. With this set-up, you typically make regular (often monthly) payments over the term of the loan, then pay a significantly larger sum at the end of the loan’s term.

Balloon payments are most commonly used for business loans, though they are also available on some auto loans and mortgages.

How Does a Balloon Payment Work?

A balloon payment loan works just like any other installment loan. The only difference is that the amount of the final payment is usually substantially higher than the previous payments.

The balloon payment may simply be a weighted payment amount. In many cases, though, the installment payments go towards interest only and the balloon payment covers the entire principle. With this set-up, the interest you pay each month is typically a fixed amount, since the principal balance does not change.

While balloon payments allow you to reduce the size of your regular loan payments, these loans tend to come with shorter terms than traditional installment loans, which means the final, large payment may be due after a few months or years.

Balloon loans represent an increased risk to the lender (who must trust that you will come through in the end). As a result, they can be more difficult to qualify for than traditional loans. Typically, lenders will only offer a balloon payment to individuals and businesses with excellent credit, solid cash savings, and stable income streams.

How Are Balloon Payments Used in Mortgage Loans?

A balloon mortgage allows you to get a lower monthly payment than you would with a traditional mortgage. For example, an interest-only mortgage loan is a type of balloon loan that allows you to defer paying down principal for five to 10 years and instead make interest-only payments.

In some cases, borrowers will try to sell the home or refinance before the balloon payment deadline. But this approach isn’t without risk. If the value of your property goes down or you experience a job loss or other financial hardship, you may not be able to sell or refinance before the balloon payment comes due. If you can’t make the payment, you risk losing your home to foreclosure.

However, if you plan only to live in a home for a few years or you’re planning to flip the property, a balloon mortgage might be worth considering. You could then use the proceeds from the sale of the home to make the balloon payment.

How Are Balloon Payments Used in Auto Loans?

Though not common, balloon payments are sometimes offered by auto lenders. Like other balloon loans, this type of auto financing allows you to pay less at the beginning, then make a much larger final payment.

A balloon auto loan might be helpful for someone who has an urgent need to purchase a vehicle (perhaps to earn money), but may not have the current income to support higher monthly payments. Once the borrower has a steady income, they would be able to make the balloon payment.

Just as with other types of balloon loans, however, this type of car loan comes with risks. If your income doesn’t increase, you may not be able to pay the lump sum when it comes due. If you skip your balloon payment, your lender could repossess your vehicle, send you to collections, or both. Either way, you risk damaging your credit, which could make it difficult for you to get financing in the future.

How Are Balloon Payments Used in Business Loans?

A balloon business loan can be an attractive option to a business with short-term financial need or that is looking to purchase commercial real estate. It enables you to get the capital you need to grow your business while you wait for that big payday from a customer.

For example, a balloon business loan might work better than other types of small business loans if you’re looking to purchase new office, warehouse, or retail space before selling your old space, since the delayed payment set-up can give you time to sell the old property.

Of course, balloon loans pose the same risks to businesses as to consumers. If your company doesn’t have a guaranteed source of income, it can be dicey to take on a small business loan that demands a large lump sum payment. While refinancing may be an option to get out of a balloon payment, there’s no guarantee that a lender will grant you a new loan.

If you’re unable to make your balloon payment, the lender may begin legal action to collect their money, which can include seizing business or personal assets. And they may report negative information to credit reporting agencies, causing damage to your business credit and possibly your personal credit as well.

Recommended: What You Should Know About Short-Term Business Loans

Advantages and Disadvantages of Balloon Payments

As with all types of financing, balloon payments come with pros and cons. Here’s a look at how they stack up.

Advantages of Balloon Payments

One of the biggest advantages of balloon payments is the lower initial payment amounts. During the fixed period, monthly payments are generally smaller than they would be for a traditional installment loan, which could be helpful if you have limited income or annual business revenue.

Smaller upfront payment requirements can also allow you to borrow more than you would otherwise be able to manage. Also, if you own a business, the lower payments can free up capital for other uses that could pay off by the time the balloon payment is due. A delayed large payment could also mesh well if you expect your salary or business revenues to increase over time.

Recommended: Business Loan Brokers

Disadvantages of Balloon Payments

If you use a balloon loan to purchase an asset, such as a home or car, you may build little to no equity in that asset despite making consistent payments. This is especially true if your installment payments are interest only. Lack of equity can make it difficult to refinance the loan.

These loans also tend to be riskier than traditional loans – both for individuals and businesses. If you can’t come up with the balloon payment at the end, you may need to refinance, potentially at a higher annual percentage rate (APR). If you aren’t able to refinance, you could end up defaulting on the loan.

4 Ways to Get Rid of a Balloon Payment

If you aren’t ready to make a balloon payment when it comes due, you may have some options. Here are four ways to potentially get rid of a balloon payment.

1. Extend the Loan

If you need more time to come up with the balloon payment, you may be able to negotiate an extension with your lender.

Similar to refinancing, an extension changes the terms of your original loan. With an extension, however, you typically don’t receive an entirely new deal. You’ll just be changing the date of the balloon payment. Keep in mind that there may be fees involved and you can typically only get a short-term extension.

2. Sell the Asset

If you used the balloon loan to buy an asset, such as a property or a car, you may be able to sell that asset to come up with the cash needed for the balloon payment.

3. Pay the Principal Upfront

One effective way to get rid of, or reduce, a balloon payment is to increase your installment payments so that they include some of (or more of) the principal. This can also lower your interest costs. Just check to make sure there aren’t any prepayment penalties or fees.

4. Refinance the Loan

Another way to avoid making a balloon payment is to refinance the loan with a different lender before it’s due. You could then use the proceeds from the new loan to make the balloon payment. Moving forward, you would make payments on your new loan.

Recommended: Debt Instruments Explained

Balloon Payment vs Adjustable-Rate Mortgage (ARM)

You’re likely considering a balloon mortgage because you want the luxury of lower payments. However, you might be able to achieve a similar result with an adjustable-rate mortgage (ARM).

With an ARM, you typically pay a predetermined APR for a period of one to five years. Usually, this rate is lower than what you would get with a comparable fixed-rate mortgage. Unlike balloon loans, though, the entire balance of an ARM doesn’t come due at once.

Instead, the interest rate and payments adjust throughout the loan term. After the guaranteed rate period ends, the interest rate is re-calculated based on current market conditions, which means it could end up being higher or lower than the initial rate. Depending on the loan agreement, the APR may adjust multiple times over the course of the loan.

An ARM can give you lower monthly payments, at least for the fixed period of the loan, but comes with risks. If interest rates rise, you’ll likely end up paying more in interest over the life of the loan than you would have if you had taken out a fixed rate mortgage. However, the lower initial monthly payment may be worth it if you’re stretching to afford the home and feel confident that your income is on the rise.

Recommended: What Is a Commercial Bridge Loan?

Other Ways to Reduce Monthly Loan Payments

Getting a balloon payment is not the only way to lower your initial payments on a loan. Here are some other strategies you may want to consider.

Large Down Payment

The larger your down payment on a loan, the less you will need to borrow, and the less you borrow, generally the lower your monthly payment will be. A bigger down payment can also result in a lower APR, which could further lower your monthly payments.

Refinancing

You may be able to lower your payments on an existing loan by refinancing, which involves swapping your existing loan for a new one with more favorable terms. If you can get a new loan with a lower APR, your monthly payments will decrease, as will the total cost of your loan.

Longer Loan Term

Another way to pay less each month on a loan is to choose a longer term. If you already have a loan, you may be able to requalify for refinancing that extends your loan repayment term. Just be aware that a longer loan term means accumulating more interest charges over time. APRs on long-term loans can also be higher. As a result, this approach will typically increase the total cost of your loan.

Recommended: Commercial Real Estate Loans

The Takeaway

Balloon loans allow borrowers to have lower payments at the beginning of a loan in exchange for a larger – balloon – payment at the end of the loan’s term.

Whether you’re a consumer or a business owner, it’s important to remember that balloon loans aren’t actually more affordable — they simply spread the total cost out in a different way.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

How exactly do balloon payments work?

A balloon payment loan works in a similar way to other types of installment loans. You receive the proceeds of the loan up front then make payments according to a fixed schedule. The only difference is that the initial payments are lower than what you would pay with a traditional installment loan, and the final (balloon) payment is higher.

Are balloon payments a good idea generally?

Balloon loans tend to be risky due to the large payments that are due at the end of the loan term. However, this type of financing might be useful for some borrowers, such as a business that has an immediate financing need and a predictable future income.

Photo credit: iStock/skodonnell

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Depreciation and amortization are methods for deducting the cost of business assets over a number of years, as opposed to writing off the entire cost the year you make the purchase. The concept behind both is to match the expense of acquiring an asset with the revenue it generates.

The key difference between depreciation and amortization is the type of asset being expensed: Depreciation is used for tangible (physical) assets, while amortization is used for intangible (non-physical) assets.

Read on to learn exactly how depreciation and amortization work, how these two accounting methods are similar and different, and when to choose one or the other.

What Is Amortization and How Does It Work?

Amortization is a method of spreading the cost of an intangible asset over a specific period of time, typically the course of its useful life. Intangible assets are non-physical in nature, but are nonetheless considered valuable assets to a business.

Types of intangible assets a business may have include:

•   Patents

•   Trademarks

•   Copyrights

•   Software

•   Franchise agreement

•   Licenses

•   Organizational costs

•   Costs of issuing bonds to raise capital

Amortization is typically expensed on a straight-line basis, which means that you would divide the total cost of the asset by the number of years it will provide use to the business, then deduct that amount each year.

To determine an intangible asset’s useful life, you need to consider the length of time that the asset is expected to produce benefits for the business. An intangible asset’s useful life can also be the length of the contract that allows for the use of the asset.

(Something to note: The term “amortization” is also used in a different way in relation to loans, such as the amortization of a car loan or mortgage. The loan amortization process involves making fixed payments each pay period with varying interest, depending on the balance.)

What Is Depreciation and How Does It Work?

Depreciation is the process of spreading the cost of a tangible or fixed asset over a specific period of time, typically the asset’s useful life. Tangible business assets (which the IRS refers to as “property”) are high-cost physical items that are owned by a business and are expected to last more than a year. They include:

•   Buildings

•   Equipment

•   Computers

•   Office furniture

•   Vehicles

•   Machinery

Unlike intangible assets, tangible assets typically still have some value even after they are no longer of use to a business. This value is known as resale or “salvage” value. Because the IRS assumes you will sell off the asset at some point, this amount must be accounted for in the beginning.

What is the useful life of a tangible asset? You can refer to IRS Publication 946 for guidance, which provides useful life by asset type. For office furniture, for example, it’s seven years. For computers, it’s three years.

To calculate depreciation, you need to first subtract the asset’s estimated salvage value from its original cost. Using the straight-line deduction method, you would then take that number and divide it by the number of years the asset will be of use to your business. There are other methods of depreciation that accelerate the process, meaning that a larger portion of the asset’s value is expensed in the early years of the asset’s life.

Recommended: Business Cash Management, Explained

Amortization vs Depreciation

Similarities

Both depreciation and amortization are accounting methods used to spread the cost of an asset over a specified period of time. And with both, you are able to deduct a certain portion of the asset’s cost — and reduce your tax burden — each year for the number of years that asset is of value to your business.

In addition, both depreciation and amortization are non-cash expenses, which means they are reported on the income statement of the company but no cash is spent.

Differences

The key difference between amortization and depreciation is that amortization is used for intangible property (meaning property you can’t pick up and hold), such as a patent or computer software program.

Depreciation, on the other hand, is used for fixed assets or tangible property (meaning assets that are physical in nature), such as computers, manufacturing equipment, and cars.

Another distinction: With depreciation, you cannot deduct the full cost of the asset. You must account for its resale value at the end of its useful life. For example, if you pay $20,000 for a piece of farming equipment and at the end of its useful life (10 years) you think you’ll be able to sell it for $5,000, then you would only deduct $15,000 over the course of 10 years.

In addition, amortization is almost always implemented using the straight-line method, whereas depreciation can be implemented using either the straight-line or an accelerated method.

Recommended: What Is EBITDA?

Amortization Example

How amortization works is relatively simple. Let’s say you purchase a license for $10,000 and the license will expire in 10 years. Since the license is an intangible asset, it would have no salvage value and the full cost would be amortized over that 10-year period.

Using the straight-line method of amortization, your annual amortization expense for the license will be $1,000 ($10,000/10 years), meaning the asset will decline in value by $1,000 every year and you would be able to deduct $1,000 each year on your taxes.

Recommended: Installment Loan vs Revolving Credit

Depreciation Example

Depreciation works in a very similar way to amortization, except that you must account for salvage value. Let’s say you purchase a $3,000 computer for your company. Per the IRS, a computer has a useful life of 36 months (or three years). After three years, you determine you’ll likely be able to sell it for $300. Here are the calculations you would make:

$3,000 – $300 = $2,700

$2,700/3 = $900

That means that each year for three years, you would be able to deduct $900 on your taxes.

Keep in mind that after the end of the computer’s designated useful life, you can (but are not obligated to) sell that computer. Either way, you would stop deducting the item’s depreciation as a business expense.

Recommended: Fixed vs Variable Rate Business Loan

The Takeaway

Depreciation and amortization are both methods of calculating the value of business assets over time. Amortization vs. depreciation just depends on the type of asset you have acquired for your business.

Amortization is used for intangible (non-physical) assets, while depreciation is for tangible (physical) assets. As a business owner, you will want to calculate these expense amounts in order to use them as a tax deduction and reduce your business’s tax liability.

If you’re in the market to purchase an asset (tangible or intangible) for your company but don’t want to deplete your cash reserves, you may want to explore funding options, such as a small business loan, equipment financing, or inventory financing.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

Do buildings depreciate or amortize

Buildings are fixed assets, so they depreciate.

Can an asset amortize and depreciate at the same time?

No. Amortization is used to spread out the cost of an intangible asset over time, while depreciation is used to spread out the cost of a tangible asset over time. An asset is either tangible or intangible — it can’t be both.

Is rent considered amortization?

No, paying rent is an operating expense for your business. If you own a rental property, however, you can use depreciation to spread the cost of buying or improving the property across the useful life of the property.

Photo credit: iStock/Pinkypills

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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