Understanding Multifamily Lingo: “Interest Only Period”Mar 13, 2020
I see an interest only period being used far too often by students. I will tell you what the problem is when using an interest only, and the only time it makes sense to use one.
Interest only is typically used only for value-add deals. If it's a performing asset, we don't go to interest only. There's a reason for that.
At some point, when that interest only period burns off and it becomes what we call an amortizing debt, your mortgage payments are going to go up considerably. If you do not have any corresponding increase in income that you are hoping to do when you do the value-add, then your cash on cash is going to go in the toilet. Your investors are going to say, “hey what the heck did you do?” And the whole thing will look terrible.
The only time I like to use value-add, interest only is when we're talking about a value add property. You see it on bridge loans and on rehab loans.
There's an exception to every rule and in this particular case. The exception is, the only time you'd ever want to do an interest only when you want a performing asset, is when you're stealing the property. When even after the amortization period has burnt off, you're still getting a great return. Then an interest only might work.
But if you're looking at buying a property that's stable - it’s got a solid vacancy and you're looking at 2% rent increase every year- then, there's really no reason to do an interest only. It'll come back to bite you. So that's the reason why I'm not a huge fan of interest only. It has it's time and it's place but you better know when to use it.