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Interest-Only Loans in Commercial Real Estate
An interest-only loan is a type of loan in which the borrower only needs to pay the interest, not the principal, for a specific amount of time. This period will typically be laid out in the loan agreement. After the interest-only period of the loan ends, the loan will become a typical, amortizing loan, in which the borrower contributes to both the interest and the principal of the loan with each payment.
- What is an Interest-Only Loan in Commercial Real Estate?
- The Benefits of Interest-Only Loans for Commercial Real Estate Investors and Developers
- The Drawbacks of Interest-Only Loans in Commercial Real Estate
- Questions? Fill out the form below to speak with a commercial real estate loan specialist.
- Related Questions
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What is an Interest-Only Loan in Commercial Real Estate?
An interest-only loan is a type of loan in which the borrower only pays the interest, not the principal, for a specific amount of time. This period is typically be laid out in the loan agreement. After the interest-only period of the loan ends, the loan becomes a typical, amortizing loan, in which the borrower contributes to both the interest and the principal of the loan with each payment.
The Benefits of Interest-Only Loans for Commercial Real Estate Investors and Developers
The most important benefit of interest-only loans in commercial real estate is the fact that they allow a property or business to have significantly more cash flow during the interest-only period. Since a borrower doesn't have to worry about paying off the principal for a few years, they have a lot more flexibility. This often means they can reinvest any profits they might have back into the business. Plus, in multifamily real estate developments, an interest-only period takes a lot of the pressure off a developer to have an extremely high occupancy rate from the start.
Many, if not most commercial construction loans have an interest-only period which is designed to last for the duration of the project's construction. That way, a developer doesn't have to worry about making payments on the principal until they can begin to realize some revenue from the project. In addition, many bridge loans and most mezzanine loans are interest-only, and certain CMBS loans are interest-only as well. Freddie Mac® and Fannie Mae® also offer interest-only options for some of their products, like Freddie Mac Fixed-Rate Conventional Loans, Freddie Mac Seniors Housing Loans, and Fannie Mae® Reduced Occupancy Affordable Rehab Loans.
The Drawbacks of Interest-Only Loans in Commercial Real Estate
Despite the benefits that interest-only loans provide, they have several disadvantages as well. Most importantly, when a borrower isn't paying any of the loan's principal, their loan payments get significantly larger when the amortization period of the loan begins (larger than if it had been amortizing from the start). And, if a borrower isn't ready to handle these payments, they could default on the loan. Also, since a borrower won't have built up any equity in their property during the interest-only period, if property values go down, they could easily find themselves underwater on their mortgage (owing more than the property is worth.)
Questions? Fill out the form below to speak with a commercial real estate loan specialist.
Related Questions
What is an interest-only loan in commercial real estate?
An interest-only loan is a type of loan in which the borrower only pays the interest, not the principal, for a specific amount of time. This period is typically laid out in the loan agreement. After the interest-only period of the loan ends, the loan becomes a typical, amortizing loan, in which the borrower contributes to both the interest and the principal of the loan with each payment.
Interest-only loans can be beneficial for borrowers who need to conserve cash flow, as the payments are lower than a traditional amortizing loan. However, there are risks associated with interest-only loans, such as the borrower having to pay a large lump sum at the end of the interest-only period.
What are the advantages and disadvantages of an interest-only loan?
The advantages of an interest-only loan are that it conserves cash flow in the short term and monthly payments are lower than if you were paying both principal and interest.
The drawbacks of an interest-only loan are that when the amortization period of the loan begins, payments get significantly larger than if it had been amortizing from the start. Additionally, since a borrower won't have built up any equity in their property during the interest-only period, if property values go down, they could easily find themselves underwater on their mortgage (owing more than the property is worth).
What types of commercial real estate properties are eligible for an interest-only loan?
Many lenders offer interest-only loans for a variety of commercial real estate properties, including construction loans, bridge loans, mezzanine loans, and agency and government-backed loans such as HUD, Fannie Mae®, or Freddie Mac®. Specifically, Freddie Mac® Fixed-Rate Conventional Loans, Freddie Mac Senior Housing Loans, and Fannie Mae Reduced Occupancy Affordable Rehab Loans are all eligible for interest-only payments.
What are the qualifications for an interest-only loan in commercial real estate?
The qualifications for an interest-only loan in commercial real estate vary depending on the lender and the type of loan. Generally, lenders will look at the borrower's credit score, income, and the value of the property being financed. Additionally, lenders may require a down payment, a minimum loan amount, and a maximum loan-to-value ratio.
For more information, please fill out the form below to speak with a commercial real estate loan specialist.
What are the interest rates for an interest-only loan in commercial real estate?
Interest rates for an interest-only loan in commercial real estate vary depending on the lender and the borrower's creditworthiness. Generally, interest-only loans have higher interest rates than traditional amortizing loans. The interest rate for an interest-only loan can range from 4.5% to 12%, depending on the lender and the borrower's creditworthiness.
What are the repayment terms for an interest-only loan in commercial real estate?
The repayment terms for an interest-only loan in commercial real estate depend on the loan agreement. Generally, the borrower pays only the interest for a set period of time, and then the loan becomes a typical, amortizing loan, in which the borrower contributes to both the interest and the principal of the loan with each payment.