What is an Interest-Only Real Estate Loan?
An interest-only real estate loan refers to a particular type of commercial mortgage that allows you to make payments on only the interest for the loan amount for a stated period. Your beginning monthly payments on an interest-only real estate loan will be significantly lower than with a traditional mortgage, which can be beneficial to you as an investor.
With an interest-only real estate loan, you will have a fixed rate for a period of 5, 7 or 10 years. Over this stated period, you can pay only interest for the principal amount. Once the period has ended, your loan will revert to the usual payment schedule of paying back a loan with amortization.
An interest-only real estate loan come in two forms. It will either will carry either a fixed rate period to begin and then an adjustable rate mortgage (ARM) after the interest-only period, or have a fixed interest rate for the entirety of its term. When you are searching for your loan, you will realize that each lender offers different types of programs in regards to the rates available.
Interest rates for real estate loans are typically higher than those of your traditional home mortgage. It’s typical for interest rates to range between 3% and 6%, which depends on the size of your loan. In addition to the interest rates, your loan will come with other fees such as origination costs, closing costs, and appraisal fees.
Interest-only real estate loans have requirements that fluctuate based on the program of the loan, the total loan amount, and your credit history (you may want to see our credit rebuilding guide). To get approved for an interest-only real estate loan, you will need a strong credit score (higher than 660).
It’s essential to remember that the lower your credit score, the stricter the credit requirements. You will need to have solid creditworthiness to demonstrate that you will be able to make the monthly payments. It’s also required that you put down 20-30% of the purchase price and that you have enough cash reserves that equal the first six months of payments.
Advantages and Disadvantages
One benefit, if you’re in the market for an interest-only real estate loan, is that you can make small initial monthly payments. During this period, you’ll have the opportunity to work on the growth of your income, so you contribute a more substantial payment toward your future debt. Another benefit of the interest-only payment schedule period is that it will allow you to get the space you need even if you can’t afford a traditional structured loan during your growth period.
A major drawback to the structure of an interest-only loan is that your monthly payments will increase significantly when the interest-only period ends. This creates the risk of not being able to pay the higher monthly payments, which could result in default.
How to Get an Interest-Only Real Estate Loan
To get an interest-only real estate loan, you will need to go through a commercial bank or commercial mortgage company. Your typical home loan lenders don’t offer products for real estate purposes. Getting approved for an interest-only real estate loan will be a bit more taxing than a conventional loan.
Once you find a bank, your financial documents from the last 3 to 5 years will be required, such as accounting reports or tax statements. If your credit is strong and your financial documents are in good standing, you have made the right steps for getting approved.
An interest-only real estate loan can benefit you if you want to reduce your initial monthly payments. However, make sure to evaluate all of the qualification requirements and disadvantages to conclude that an interest-only real estate loan will benefit your real estate investments.