Understanding Interest Only Loans

An interest only loan is when the borrower is required to make interest only payments while making no principal reduction. This type of loan is typically used for commercial real estate loans, and specifically most often with bridge loans, value-add renovations, and construction loans. Interest only loans are appropriate when there is a gap between the purchase, or construction, of a property and the time at which it begins producing steady income.

Benefits

The main benefit of interest only loans is that they allow for the borrower to hold onto their capital. This would be necessary for an investor who is waiting to secure cash flow from a property in order to afford an amortizing payment. Another reason might be that construction and/or renovations to the property have not yet finished, therefore the reduced loan payments can help the borrower better cash flow to finalize the project. Lastly, a borrower would benefit from an interest only loan while they wait for a property to be sold or refinanced.

Risks

Interest only loans are typically short-term, lasting 12 to 36 months. Another downside of interest only payments is that they do not reduce the loan’s principal balance. This can be risky if the value of the property declines, leaving the borrower responsible for paying more than what the property is worth.?

Tips For Success

• Implement a value add business plan
• Keep your underwriting conservative
• Complete extensive research on market factors influencing your property
• Maintain a healthy credit score
• Choose a lender who is direct and provides extensive knowledge and experience working with interest only loans

Interest only loans can be very useful in certain situations, however, as with any investment financing, you’ll want to be aware of the potential risks and stay ahead of the game as much as possible.

CALCAP Lending offers competitive terms on residential real estate investment loans, single family, and multifamily. In addition, CALCAP Lending offers preferred equity investments. Find out how CALCAP Lending can efficiently help you fund your next project by contacting us at 833.816.5580 or visit us online.