CRE 101 · deweyluong.realtor

Interest-Only Loans Explained: The Lower Payment That Buys Time, Not Equity

An interest-only (IO) loan lets a commercial borrower pay just the interest for a set period — no principal at all — which makes the early payments dramatically cheaper and the early cash flow dramatically prettier. The loan, however, does not shrink by one dollar while it lasts. On the made-up example on this page, a $3,000,000 loan at 6.5% costs $16,250 a month interest-only against $20,256 amortizing — a $4,006 monthly difference that lifts cash flow from about $36,925 to $85,000 a year — and then leaves about $2,716,865, roughly 90.6% of the original balance, still owed at year ten. By Túy “Dewey” Luong, CCIM — Founding Broker, SERHANT. Atlanta · 318 closed sales / $281.2M career volume · 678-707-2498

The worked example uses made-up, rounded numbers to teach the mechanics. Real interest-only terms are set loan by loan — IO periods, amortization schedules, and the covenants tested during the IO years all vary by lender and program. This page is general education, not legal, lending, or tax advice.

What an interest-only loan actually is

• Interest-only is a period, not a loan type: most commercial IO is a feature inside an ordinary loan — a five-, seven-, or ten-year term with 25- or 30-year amortization, where the first stretch of payments (two, three, five years, or occasionally the full term) covers interest only. When the IO period ends, the same loan converts to amortizing payments for whatever time is left.
• The math is deliberately simple: the IO payment is the loan balance times the rate divided by twelve — nothing else. Nothing amortizes, so the payment never changes during the IO years and the balance never moves. That simplicity is the attraction: the borrower knows the exact payment to the dollar, and not one dollar of it is principal.
• Zero principal means zero forced equity: an amortizing payment is part rent to the lender and part forced savings — every month the balance falls and the owner's equity grows even if the property's value never changes. An IO payment is pure rent. After five interest-only years on this page's example, the borrower has paid $975,000 of interest and reduced the balance by exactly $0.
• Lenders underwrite past the IO period anyway: no serious lender sizes a loan to the IO payment. Underwriting tests coverage at the amortizing payment — the same discipline the CMBS lesson describes — because the lender's real question is whether the property survives the payment it will eventually owe. A borrower shopping loans by the IO payment is comparing the wrong number across every term sheet.
• Full-term IO exists, and it is a different animal: some conduit and agency loans run interest-only to maturity, which converts the entire loan into a single balloon at the end — the full original balance, due on one date. Partial IO defers principal; full-term IO deletes it, and the refinance plan stops being a detail and becomes the whole strategy.
• The fine print runs during the IO years too: coverage covenants, reserve escrows, and reporting obligations generally apply from day one, often tested at the amortizing payment even while IO checks are being written. And prepayment rules — yield maintenance, defeasance, or step-downs — do not pause just because principal payments do.

Worked example: one retail center, one loan, two payments (made-up numbers, labeled as such)

• The setup: a stabilized neighborhood retail center in Gwinnett priced at $4,000,000 with NOI of $280,000 — a 7.0% cap rate. The buyer puts $1,000,000 down and borrows $3,000,000, 75% of value, at a made-up fixed 6.5%: ten-year term, 25-year amortization, first five years interest-only.
• The interest-only years: the payment is $3,000,000 times 6.5%, divided by twelve — $16,250 a month, $195,000 a year. Against NOI of $280,000, coverage looks plush at 1.44x, and cash flow after debt service runs $85,000 a year. The debt yield is 9.3%. On paper, the deal breathes easily.
• The amortizing payment the loan was actually underwritten to: spread over the 25-year schedule, the same $3,000,000 at 6.5% costs about $20,256 a month — $243,075 a year. Coverage at that payment is 1.15x, and true cash flow is about $36,925 a year. The IO years do not create the other $48,075 of annual cash flow; they borrow it from the loan's own principal schedule.
• The payment shock: when the IO period ends at year five, the payment jumps by about $4,006 a month — roughly 24.7% — overnight, on a loan with only five years left to amortize over the remaining schedule. Nothing about the property changed. Owners who spent the IO years distributing the $85,000 as if it were run-rate income meet the $20,256 payment with a property that still produces $280,000 and a reserve account that was never funded.
• The balloon at year ten: the five amortizing years pay down only about $283,135 of principal — 9.4% of the loan. At maturity the borrower still owes about $2,716,865, roughly 90.6% of the original $3,000,000. Had the loan amortized from day one, ten years of payments would have cut the balance to about $2,325,341 (77.5%). The five IO years leave the borrower about $391,524 deeper in debt on refinance day — in exchange for $48,075 a year of extra early cash flow, most of which disciplined owners would have had to hold as reserves anyway.
• The honest ledger: five IO years cost $975,000 of interest and retire no principal at all. Across the full decade this loan retires about $283,135 of balance; the same loan amortizing from day one would have retired about $674,659. Interest-only is not cheaper money. It is the same money with the principal payments moved to the end — where they arrive all at once, at whatever rates and appraisals that future year offers.

When it works — and where it breaks

• It works when the IO years have a job: a lease-up or repositioning plan where rent genuinely rises before amortization starts; a construction or renovation window where the property cannot yet carry full debt service; a value-add deal with a dated, credible exit. In each case the IO period buys time for income to grow into the real payment — the coverage the property will need is being built, not merely hoped for.
• It works when the borrower banks the difference: an owner who collects the $85,000, spends the deal as if it paid $36,925, and reserves the roughly $48,075 gap has effectively self-amortized — the balloon then meets a funded reserve instead of a surprised owner. IO rewards exactly the discipline it tempts borrowers to skip.
• It breaks when the plan is the payment: if the deal only pencils at the IO payment, the deal does not pencil. Underwriting at 1.15x coverage on the amortizing number is the lender telling the borrower, in advance, that this property is thin for this loan — a fact the IO years conceal but do not change, as the leverage lesson shows from the other side.
• It breaks at the balloon: 90.6% of the balance comes due in a single year, refinanced against that year's appraisal, that year's rates, and that year's rent roll. A loan taken at 75% of value can return as a loan request at 85% of a lower value without the owner spending a dime — the IO years spent the paydown instead.
• It breaks when income falls during the IO window: an amortizing loan self-corrects a little every month — the balance falls whether the tenant stays or goes. An interest-only balance stands perfectly still while the property moves, so a lost anchor tenant in year four hits a borrower who owes every dollar they borrowed in year one.

Cho nhà đầu tư người Việt

Interest-only (chỉ trả lãi) là giai đoạn người vay chỉ trả tiền lãi, không trả đồng gốc nào — khoản trả rẻ hơn hẳn, nhưng dư nợ không giảm một đô la. Ví dụ giả định trên trang này: một trung tâm bán lẻ ở Gwinnett giá $4.000.000, NOI $280.000. Khoản vay $3.000.000 (75% giá trị), lãi suất cố định 6,5%, kỳ hạn 10 năm, trả góp theo lịch 25 năm, năm năm đầu chỉ trả lãi. Khoản trả interest-only là $16.250 mỗi tháng — DSCR trông rất đẹp ở mức 1,44 lần và dòng tiền $85.000 một năm. Nhưng ngân hàng thẩm định theo khoản trả đủ gốc và lãi: khoảng $20.256 mỗi tháng, DSCR thật chỉ 1,15 lần và dòng tiền thật khoảng $36.925 một năm. Năm năm chỉ trả lãi tốn $975.000 tiền lãi và không giảm được đồng gốc nào. Khi giai đoạn chỉ trả lãi kết thúc, khoản trả nhảy thêm khoảng $4.006 mỗi tháng — tăng 24,7% — trong một đêm. Đến năm thứ 10, dư nợ vẫn còn khoảng $2.716.865, tức 90,6% khoản vay ban đầu: ngày đáo hạn là một sự kiện phải tái cấp vốn hoặc bán với gần như nguyên vẹn khoản nợ. Nếu trả góp từ ngày đầu, sau 10 năm dư nợ chỉ còn khoảng $2.325.341. Interest-only hợp lý khi thời gian mua được có việc cụ thể — lấp đầy mặt bằng, cải tạo, tăng tiền thuê — và khi chủ sở hữu giữ lại phần chênh lệch làm dự phòng. Nó vỡ khi thương vụ chỉ “có lãi” nhờ khoản trả interest-only. Đây là thông tin giáo dục chung, không phải tư vấn cho vay hay pháp lý — hãy làm việc với luật sư và chuyên gia tài chính của bạn trước khi ký.

Frequently asked questions

What is an interest-only loan in commercial real estate?

It is a loan — or, more commonly, a period inside a loan — where the borrower's payment covers only interest and no principal. The balance does not decline during the interest-only period. On this page's made-up example, a $3,000,000 loan at 6.5% costs $16,250 a month interest-only, against about $20,256 amortizing on a 25-year schedule, and five interest-only years leave the full $3,000,000 still owed when amortization begins.

Why do commercial borrowers choose interest-only?

To buy time and early cash flow. An interest-only period can carry a property through lease-up, renovation, or repositioning until its income can support the amortizing payment, and it maximizes distributable cash in the early years of a deal with a dated exit. The trade is exact: every dollar of principal not paid early remains owed at the balloon — on the worked example, about $2,716,865 of a $3,000,000 loan is still outstanding at year ten.

How much lower is an interest-only payment?

It depends entirely on the rate and the amortization schedule it is compared against. On the worked example — $3,000,000 at 6.5% — the interest-only payment of $16,250 is about $4,006 a month, or roughly 24.7%, below the 25-year amortizing payment of about $20,256. The gap widens at higher rates and shorter amortization schedules, and it is a deferral, not a discount: total principal owed is unchanged.

What happens when the interest-only period ends?

The loan converts to amortizing payments for the remainder of the term, and the payment steps up — about 24.7% on the worked example. If the structure is interest-only for the full term, there is no step-up; instead the entire original balance comes due at maturity as a balloon. Either way, lenders underwrite the loan to the amortizing payment from day one, so the borrower's plan should be built on that number, not the interest-only one.

Interest-only (chỉ trả lãi) là gì?

Là khoản vay — hay chính xác hơn, một giai đoạn trong khoản vay — mà người vay chỉ trả tiền lãi, không trả gốc, nên dư nợ không giảm trong suốt giai đoạn đó. Trong ví dụ của trang này, khoản vay $3.000.000 lãi suất 6,5% có khoản trả chỉ trả lãi là $16.250 mỗi tháng so với khoảng $20.256 khi trả đủ gốc và lãi; ngân hàng thẩm định ở DSCR 1,15 lần theo khoản trả đầy đủ, và sau 10 năm dư nợ vẫn còn khoảng $2.716.865. Đây là thông tin giáo dục chung, không phải tư vấn cho vay hay pháp lý.

Looking at a term sheet with an interest-only period — and want to know what the payment, the coverage, and the balloon really look like in year six and year ten? Call Túy “Dewey” Luong, CCIM at 678-707-2498 or see SERHANT. Atlanta.