| Detail | Explanation |
|---|---|
| Payment | Loan balance x interest rate / 12 |
| Forms | Full-term interest only or a partial interest-only period |
| Common on | Bridge, construction, lower-leverage permanent, and CMBS loans |
| Tradeoff | Higher balance at maturity and often lower maximum leverage |
How is an interest-only payment calculated?
The payment covers only the interest that accrues each month. Nothing goes to principal, so the balance at the end of the interest-only period equals the balance at the start. When a partial interest-only period ends, the loan converts to principal and interest payments on the amortization schedule in the loan documents.
Monthly interest-only payment = loan balance x annual rate / 12
Worked example
In this hypothetical example, a $5,000,000 loan at 7.00% has a 10-year term. The interest-only payment is $29,167 a month, or $350,000 a year. Amortizing on a 30-year schedule from day 1 would cost $33,265 a month, or $399,181 a year, so the interest-only structure saves $49,181 a year in payments.
| Structure | Balance at maturity |
|---|---|
| Amortizing from month 1 on a 30-year schedule | $4,290,619 |
| 3 years interest only, then 30-year amortization | $4,557,371 |
| Interest only for the full 10 years | $5,000,000 |
Does interest only help you qualify for a larger loan?
Less than many borrowers expect. If the hypothetical property earns $500,000 of net operating income, coverage is 1.43x on the interest-only payment and 1.25x on the amortizing payment. Lenders frequently underwrite the amortizing figure. Freddie Mac's term sheet for Optigo fixed-rate multifamily loans states that the debt coverage ratio for partial and full-term interest-only loans is calculated on an amortizing payment.
Leverage can also be lower. The same term sheet lists a maximum LTV of 80% for amortizing loans with terms over 7 years but 70% for full-term interest-only loans of that length, and 65% for full-term interest only on terms of 5 to under 7 years. It also requires at least 2 years of amortization for a loan to be treated as partial interest only.
When interest only makes sense
- Bridge and value-add loans, where cash flow is directed to renovations and lease-up
- Construction loans, where interest is usually paid from an interest reserve during the build
- Lower-leverage stabilized loans, where the lender is comfortable with no paydown
- Short hold periods, where the owner plans a sale before principal reduction would matter
- Newly acquired property during the early years of a business plan, through a partial interest-only period
Risks to plan for
Payments rise when a partial interest-only period ends, so sponsors should model coverage for the years after conversion as well as the initial period. The full balance remains at maturity, which increases refinance risk if values or income fall. The commercial mortgage calculator models an interest-only period followed by amortization and shows the resulting balloon payment.
To compare interest-only structures across lenders for a specific property, submit your financing request to Capital Partners.
Sources
Common questions
Can I get a 10-year interest-only commercial loan?
Full-term interest-only loans exist, especially at lower leverage and on stabilized property. Expect the lender to limit LTV or size to an amortizing payment in exchange.
Are bridge loans interest only?
Most are. Bridge lenders expect cash flow to fund the business plan and plan for repayment from a refinance or sale, so principal paydown is rarely required.
Does interest only raise the loan amount?
Only when the lender sizes coverage on the interest-only payment. Many lenders and programs underwrite an amortizing payment, so the loan amount stays the same.
What happens when the interest-only period ends?
Payments convert to principal and interest on the amortization schedule, which raises the monthly payment. The loan documents set the conversion date and schedule.
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