Interest-only loans only require you to pay the interest owed each month. You don’t have to pay toward the principal at all.

Interest-only, or “IO”, is in demand because it reduces the monthly payment, thereby increasing cash flow.

Some loans, in rare cases, are interest-only for the full term. You owe the same amount at the end of the loan as in the beginning if you didn’t pay toward the principal.

Other loans have an interest-only period, say 1-3 years, then you start paying principal and interest. As you may have guessed, your payment goes up substantially when the interest-only period ends.

In either case, you may have a balloon payment at the end of the loan term, or a lump sum due. This is because the loan didn’t require the balance to be paid down enough to retire the debt during the loan term.

While that sounds risky, most commercial loans for multifamily property have some sort of balloon payment at the end. So it might not be much more of a risk to take on an “IO loan” compared to one where you pay principal and interest each month.

Generally, interest-only loans are harder to get than loans that require principal and interest payments. Individual banks and aggressive lenders may offer more IO options than government agencies like Fannie Mae and Freddie Mac. Stilll, these agencies do grant even full-term IO for strong borrowers with large down payments.

Interest-only Benefit Example

Interest only can be a powerful tool that allows you to keep monthly debt service to a minimum and increasing cash flow for a property.

For instance, assume your yearly income on a property is $100,000. The yearly principal + interest payment might be $70,000, leaving you with $30,000 in “cushion” each year. Now imagine your interest-only payments only add up to $50,000. That leaves you with $50,000 per year with which you could invest back into the property or get you closer to managing multifamily properties full time :).

IO is a sophisticated investment tool, and used correctly, can help you achieve your real estate goals faster.