Interest Only Loans: 4 Things Borrowers Need to Know

The prevalence of interest only loans has played a significant role in the spate of developments during this economic cycle. The first part of our series focusing on this change in the landscape discussed motivations and goals from a lending perspective. In this article we’ll take a look at the benefits of interest only loans for borrowers. Here are four things borrowers should know about interest only loans.

1) Cash Flow: Cash flow is significantly greater during an interest only period of a loan than during an amortizing period. This can give an investor a greater cash on cash return for their investment.

2) Tax Advantages: All income generated by income producing properties is subject to tax. Typically the interest portion of a loan is tax deductible and the principal pay down is not. Consequently, interest only loans are more tax efficient. (confirm the details of your case with your advisor)

3) Assumability: Most investors seek maximum cash flow. An assumable loan with an interest only component can be quite desirable for a buyer on a sale.

4) Flexibility: Some loans can be structured with an interest only component and flexibility for some principal pay down without penalty. This gives the borrower flexibility within the loan. If there is an interest only component with little or no flexibility in the prepayment penalty, the borrower can accumulate cash that would have otherwise been used for principal pay down in a reserve to pay down or pay off principal when the loan matures.