Interest-only commercial real estate loans have a monthly debt service fee that they must pay. This sum represents the interest that has accrued on the loan’s principal. Debt servicing entails principal and interest payments to the lender. “principal” refers to the total amount borrowed, while “interest” refers to the cost associated with that loan.
Debt service on a loan of $11,505,500 at 5.28 percent interest for 30 years would be $60.977 monthly. The interest accrued on the loan principal is how the debt service fee is arrived at. Monthly debt service payments for a loan that doesn’t charge interest would contain both principal and interest.
An interest-only debt service payment is all you’ll have to make on a bridge loan. It’s possible that you could qualify to pay simply the interest on your loan for one year or more on a Fannie Mae or Freddie Mac agency loan. After getting approved for a loan through an agency, you may have trouble selecting whether to make interest-only payments or payments that include principal and interest. Examine the pluses and minuses of every option so that you may make a more informed call.
Gains from an Interest-Only Commercial Real Estate Loan
The advantages of interest-only loans can be significant for sponsors and individual investors in commercial real estate syndication. Major considerations for these loans include:
- Potential for a Raise in Future Income. For those about to complete rigorous professional degree programs like medical school or law school, investing in real estate may be out of reach financially. It’s understandable if the thought of taking on loan payments right now fills you with dread. Still, if you factor in how much money you could make in the future, you can feel secure about your financial situation.
Investing in real estate syndicates with manageable monthly payments is possible by acquiring an interest-only loan. Making greater monthly installments in subsequent years shouldn’t be a problem.
- Property values are rising. Leveraging expensive commercial buildings in a growing real estate market is an excellent use of an interest-only loan. A standard loan would have been too expensive for them to undertake these investments. Real estate is notoriously illiquid, but syndication makes it possible for investors to get their money out of a property before its value plummets.
- Strong Plan for Financial Success. Selling equities may not make sense if your portfolio has grown significantly in a thriving financial market. However, cash flow is often necessary for property investment. Perhaps you have enough money to cover them, but you’d rather put that money elsewhere. An interest-only loan could be the best option in either of these cases.
- Practical Tax Write-Off. Loans secured by real estate that exceed $1 million in value qualify for tax-deductible interest. This monetary benefit makes interest-only loans acceptable for syndication investors with assets in substantial commercial buildings. Your investment prowess may have put you in the upper-income tax bracket. The interest you pay on a mortgage for your home can be deducted from your taxable income. Every cent you spend toward your debt is, in fact, tax deductible.
- The loan allows for equity payments. For the most part, you can make principal payments on top of your interest payments with an interest-only loan. You can use that money to pay more on your mortgage when you have a particularly lucrative month. By doing this, you can reduce the total interest you pay throughout the life of the loan and your monthly payments.
Difficulties with Interest-Only Commercial Real Estate Loans
Getting an interest-only loan to finance your real estate investment endeavors isn’t without risks. You could run into future financial trouble if your income does not improve as quickly as you had hoped. You may not have the funds available to start making principal payments when the time comes. Since implementing the new federal consumer protection laws in 2013, lenders have become more selective when extending these types of loans.
As a borrower, you may also face the following issues with an interest-only loan agreement:
- No Increase in Equity. In most cases, applicants seeking interest-only commercial real estate loans require a large down payment. That way, the lenders will have sufficient collateral to recoup their losses if there is a default. Except in cases when the borrower pays higher or additional payments, the investor-borrower will not see any increase in their equity. Do not get an interest-only loan if paying off the principal is your priority.
- A decrease in property prices. Before the market meltdown of 2008, many people saw commercial real estate as a safe investment. The availability of interest-only loans contributed to the rapid rise in housing values.
After the bubble burst, however, the market value of the loan’s borrowers had taken out plummeted, and the borrowers were hit with massive interest payments. Many investors gave up on the real estate market altogether due to these payments because they were made on properties with a minimal stake.
- High-Interest / High-Risk Loans. There should be safeguards for borrowers whose lending agents provide interest-only loans for commercial real estate ventures. These loans are currently less transferable to other banks than they were previously. As a result, property investor borrowers are being asked for bigger down payments.
There is a premium added to interest-only loans. Also, high-interest rates reflect the larger risk taken by the lender. These days, conventional loans are often seen as the safer option.
- Changing Interest Rates. There is a high likelihood that the interest rate on an interest-only loan will fluctuate. A standard index of funds rates adjusts rates. An increase in the fund’s rate will result in a similar increase in your loan’s interest rate. The ability to lock and unlock interest rates on loans could be a significant benefit. To better plan for your financial future, consider applying for a loan of this type.
- Acceptance of a Poor Deal. It may entice you to enter into a questionable real estate transaction because it would reduce your monthly payments during the interest-only phase of your loan. Underwriting standard plus interest debt is one option for you as a sponsor or investor in a commercial property syndication project. However, the numbers from the deal could not work out the way you hoped they would.
However, the contract will line up with your expected profits if you guarantee an interest-only investment loan for three years. Your current disposable income clearly shows that a principal and interest loan is out of the question. However, you should be sure that your net operating income will rise before the end of the interest-only period if you plan on taking out an interest-only loan.
Calculating Your Loan Payments Monthly
Whether or not your interest rate fluctuates during the loan’s payback cycle directly impacts your monthly payment amount. One alternative is to fix it at a certain fraction of the outstanding loan sum. Keep in mind that your equity balance won’t change during the loan’s interest-free duration. Therefore, until the interest rate is reduced, you will not benefit from decreased monthly payments.
Sponsors and investors in syndicated properties can rest easy knowing that a traditional loan guarantees their fixed monthly payment amount. While interest is reduced over time, the principle grows in proportion to the loan balance. Interest-only loans have flexible monthly payments because they are calculated separately from the principal.
Your loan’s monthly payment may also alter if the interest rate changes or if you pay more than the required amount toward principal. Remember that the minimum payment amount may increase substantially when the interest-only period ends.
Commercial Real Estate Syndication Investor Interest-Only Loan Management
Investing in commercial real estate via a syndication agreement has the distinct advantage that each investor only has to put up a small percentage of the total investment amount. This means you can cover your share of the investment with a loan of a more manageable quantity.
Investing in real estate in this way lets you pick investments that fit comfortably within your means and investing budget. Your financial situation will never require you to apply for a standard or an interest-only loan that you cannot afford to return on time.
Concerning Interest-Only Commercial Property Loans: Pros and Cons
Borrowing money solely in the form of interest can be met with ambivalence by certain commercial real estate investors. If you’re considering investing in a property through syndication, you might consider the advantages and downsides. Since these loans require no principal payments during the interest-only period, they appear appealing to most investors. You may be a new investor and doubt your future ability to make principal payments.
While these loans may not be ideal for the average consumer, they can be highly useful for lucrative funding businesses that generate a moderate net income and are therefore attractive to more seasoned syndicated investors. These savers and traders have prepared for the future and anticipate much better income levels.
They are confident in their abilities to make the necessary principal payments on these loans when it comes. To them, it is important to be able to make investments with the help of interest-only loans so that they might reap substantial profits in the future.
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