When Does an Interest-Only Commercial Loan Make Sense for Your Client?

When advising clients on loan options, there are many considerations commercial mortgage brokers need to keep in mind. Finding your client the best possible solution means taking into account their unique situation and evaluating their needs, wants, goals, and restrictions.

One of the key issues to discuss is your client’s preference for the structure of their loan.  More specifically, do they want a loan that includes an interest-only period or would they prefer a fully-amortizing solution?

Here are 3 scenarios where an interest-only commercial loan may be a great fit for your investor or business owner client, as well as 2 instances where an interest-only solution may not be in their best interest.

When Interest-Only Commercial Mortgages Make Sense

Deals involving multifamily properties

One of the biggest challenges multifamily investors face is the pressure to secure a tenant for each unit at the beginning of their mortgage’s term.

Since rent payments make up the majority of revenue generated by multifamily properties, any vacancy could seriously limit the amount of income needed to make the loan’s initial monthly payments.

Many investors with these types of occupancy concerns prefer interest-only loans because the initial interest-only period reduces their monthly payments.  When the time comes to begin paying off both the principal and interest on their loan, they will hopefully be generating steady income through their tenants’ rents.

When a business owner requires cash-flow flexibility

Business owners who expect to renovate or improve their property in the immediate or near future may see value in securing a mortgage that includes an interest-only period.

That way, they will have more cash available to complete their initiatives and improve their business.

The hope is that the property or business improvements will help the borrower generate additional income that will make it easier to afford the loan payments once the interest-only period expires.

When an investor does not plan on owning the commercial property for a long period of time

Investors who have a long-term strategy for their commercial real estate asset may wish to pay down the principal on their loan as soon as possible.  This allows investors to start building equity through their property immediately.

But those who plan on selling their property within a few years of their purchase may prefer to keep their monthly payments as low as they can be for as long as possible.  Without a long-term plan for the property, building equity is less of a priority for these types of investors.

Why Interest-Only Loans May Not Meet Your Borrower’s Needs

Naturally, interest-only loans are not designed for every type of borrower.  Here are a few reasons why a borrower may prefer to stick with a fully-amortizing loan.

  1. Shock of monthly payment increases

Once the interest-only period on a loan of that type expires, borrowers must begin paying both the principal and interest payment each month.  If a borrower has grown accustomed to paying a certain amount, the new payment structure can be jarring.

In cases where a business owner or investor has not been able to generate sufficient revenue during the interest-only period, the transition to larger monthly payments may represent a substantial stumbling block.

  1. Lack of equity

Borrowers who build equity in their commercial property help increase the overall value of their purchase.  If they choose to, borrowers can execute a cash-out refinance and tap into the equity they’ve built over time.

But borrowers who only make interest payments on their loan are not building this type equity with their property.  Depending on a borrower’s long-term financial goals, this can be reason enough to choose a fully-amortizing loan solution.

Taking the next step

As in most cases involving commercial mortgage options, the best option for your client will depend on their financial history, financial needs, and property characteristics.

That’s why successful originators develop strong relationships with a number of lender partners.  This gives them the ability to meet the greatest number of client needs.

If you’re looking for an interest-only solution for 30-year fixed rate commercial loans, consider Silver Hill Funding, LLC’s solution.

With this new addition to our loan offering, borrowers can choose to make only interest payments for the first 5 years of their 30-year fixed rate loan.  Following the initial 5-year, interest-only term, the loan then transitions to a 25-year amortization schedule.

Our solution makes sense for non-bankable investors and business owners looking to lower payments and maximize cash flow during their loan’s initial term.

You can read more about our solution in this news post.

To learn more about all of the non-bank loan options available with Silver Hill, see our program overview page.