Is anyone using all interest loans as a strategy?

Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 800 votes

I'm trying to retrain my brain on this kind of product compared to the traditional Principal and Interest. My thought is why wouldn't I do an all interest 10 year loan at 4.99%? Prepayment penalty is only the first 3 years at a 3,2,1 rate. My thought is most of your traditional loans are mostly interest in the early years anyway so why not. This particular property has increased rents every year at 2.5% so that will be the only equity that I am building since I'm not paying down principal. The increased cash flow is a form of equity I can use/build up to keep on reinvesting. Thoughts?

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Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

Quote from @Eliott Elias:

What's your long term play? If you're holding 10 years+ avoid interest only, you're wasting time. If appreciation is your game (which I don't recommend) interest only is fine to make the property cash flow.

Actually it works great for both the CF and equity plays. Equity build up from paydown of the mortgage payments is so small in the first 20 years, it really has little impact, compared to equity gained from appreciation. Since equity gains from appreciation has nothing to do with existing equity, only property values, IO loans have no impact on it as a huge gain. The positive CF gains are obvious.

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Nick Robinson
Rental Property Investor · Murrieta, CA · Member since 2020 · 338 posts · 343 votes
3y
@John M.
I think interest-only loans are a great product. When you go interest only it helps the CF numbers a ton so it gives you more options. I would only get it on longer dated loans. In the long run the rents will go up and that will increase the value of the building way more than any principal reduction during that time. Shorter duration loans, 3yrs, I would be careful as rents are cooling off and it is hard to guess price action in the short run. Rents could come down more or even if they stabilize lending standards can become tighter making refinancing a challenge. When it is over a 10yr period you have a lot of options.
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Chris John
Member since 2020 · 671 posts · 937 votes
3y
@John M.
One of our properties is interest only and I'm starting to wonder:
1. Why aren't the others?
2. Why should I pay this thing off until I have to?
I feel like the history of our investments show that debt retirement has been far less lucrative than price appreciation and much less useful than the extra liquidity that interest only loans offer.
We've ended up refinancing our properties to help scale up anyway, so I'm wondering what the point of burying what could be extra cashflow into the houses through debt retirement is when I could keep it handy (or even have it working in mutual funds or other properties) in the meantime.
Having said all of this, I believe I'm only at the beginning stages of noodling through this. The temptation to over leverage and the disparity in the attractiveness of the loans types in terms of rates, etc. are concerns that I still need to address.
I think I'm trying to say, you're not the only one thinking about this! haha
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Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
3y
Quote from @John M.:

I'm trying to retrain my brain on this kind of product compared to the traditional Principal and Interest. My thought is why wouldn't I do an all interest 10 year loan at 4.99%? Prepayment penalty is only the first 3 years at a 3,2,1 rate. My thought is most of your traditional loans are mostly interest in the early years anyway so why not. This particular property has increased rents every year at 2.5% so that will be the only equity that I am building since I'm not paying down principal. The increased cash flow is a form of equity I can use/build up to keep on reinvesting. Thoughts?
Yes grasshopper. You have understood how money works as applied to REI, which you serve you well in future deals.
6 Reply
Kristen L GarnerBusiness Member
Lender · Phoenix, AZ · Member since 2021 · 451 posts · 287 votes
3y
I see IO loans used most heavily with my fix and flip borrowers. We also utilize an IO period to help get DSCR ratios down when doing purchases or refis where the DSCR ratio is on the boarder of making or breaking the deal.
[email protected]213-880-0434
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Eliott Elias
Investor · Austin, TX · Member since 2021 · 9k+ posts · 5k+ votes
3y
What's your long term play? If you're holding 10 years+ avoid interest only, you're wasting time. If appreciation is your game (which I don't recommend) interest only is fine to make the property cash flow.
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Taylor DaschBusiness Member
Real Estate Agent · Temple, TX · Member since 2022 · 1k+ posts · 700 votes
3y
I am currently using an only interest loan product but it is because I tanked my credit doing the rehabs and have to pick it back up. If possible at all, I would prefer to have principal pay down as well.
[email protected]254-718-4249
Taylor Dasch | EG Realty560 Reviews
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Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @John M.:

I'm trying to retrain my brain on this kind of product compared to the traditional Principal and Interest. My thought is why wouldn't I do an all interest 10 year loan at 4.99%? Prepayment penalty is only the first 3 years at a 3,2,1 rate. My thought is most of your traditional loans are mostly interest in the early years anyway so why not. This particular property has increased rents every year at 2.5% so that will be the only equity that I am building since I'm not paying down principal. The increased cash flow is a form of equity I can use/build up to keep on reinvesting. Thoughts?

IO loan for residential really works ! IF
1. you plan to sell at certain years
2. you also add meaningful additional principal to payoff the property

In combination with flip strategy, IO loan works when calculate carefully, key here one must have business plan.
1 Reply
Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
3y
Quote from @John M.:

I'm trying to retrain my brain on this kind of product compared to the traditional Principal and Interest. My thought is why wouldn't I do an all interest 10 year loan at 4.99%?

I sold 2 commercial apts to syndications last year on interest-only contracts. I love seeing the balance stay the same. My larger one is a 10 yr balloon with a 5yr pre-payment penalty of 3,3,2,2,1. Smaller is a 5yr balloon, 3 yr pre-payment. Others amortize normally.

As a buyer I would rather have it amortize down. My last few loan payments (since I'm 90% out of RE) are over 50% principal, one over 70%. Balance sheet wealth has played a much larger role than lunch money, I mean cash-flow, for me.

On your loan, what would the difference be? My 2 sales would've each been about $1200 principal, $5k interest.
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V.G JasonPro Member
Investor · Member since 2022 · 3k+ posts · 3k+ votes
3y
IO is dumb if you care about buying in the right area that'll alone give you great levels of appreciation. If you're buying in garbage neighborhoods, sure go for it. If I'm a betting man housing's real underlying value isn't the $180/mo it gives you but the totality of that and how much the house sells for. If you're focused on collecting dimes then sure use IO loans-- sell before year 10, cross your fingers you have no serious maint, and no bad tenants. It's right up there with buying turnkey as lowest possible avenues.
I'd do this strictly in areas that offer high(er) cash flow and I know the house won't go anywhere value wise. Like Little Rock or some area like that. Then if you're doing that, sure go for it. Don't buy in primo areas with it.
3 Reply
V.G JasonPro Member
Investor · Member since 2022 · 3k+ posts · 3k+ votes
3y
Quote from @Eliott Elias:

What's your long term play? If you're holding 10 years+ avoid interest only, you're wasting time. If appreciation is your game (which I don't recommend) interest only is fine to make the property cash flow.
If you're game is appreciation, why would you suggest IO?

What percentage of equity do you own when you buy a property with a 10-year IO, 30 year back end mortgage? Let's presume 25% on day 1, say January 21, 2023. What percentage do you own on January 21, 2033?

25%.

The house has appreciated. Sure your 25% then>25% now but you want to PAY DOWN principal if you're an appreciation bull. That 25% differential in absolute value won't even cover your commissions to sell.

IO works for bottom of the barrel properties, to make even more cash flow. You don't get wealthy of servicing your monthly debt, you get wealthy making cash & moving land.
1 Reply
Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
3y
Quote from @Eliott Elias:

What's your long term play? If you're holding 10 years+ avoid interest only, you're wasting time. If appreciation is your game (which I don't recommend) interest only is fine to make the property cash flow.
Actually it works great for both the CF and equity plays. Equity build up from paydown of the mortgage payments is so small in the first 20 years, it really has little impact, compared to equity gained from appreciation. Since equity gains from appreciation has nothing to do with existing equity, only property values, IO loans have no impact on it as a huge gain. The positive CF gains are obvious.
6 Reply
John M.
OP
Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 800 votes
3y
I should point out in my particular deal that this is a commercial property so the rents are built into the contract for the next 10 years. I would only sell in year 10 if I can get the lease renewed and the market was hot for a potential trade up position into another property. If I really wanted to pay down the equity I could do so at anytime by writing a check as opposed to the slow pay down appreciation that @Joe Villeneuve pointed out with a traditional loan. In my scenario the equity (value) is increased because of the guaranteed rent increases.
2 Reply
Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
3y
Quote from @John M.:

I should point out in my particular deal that this is a commercial property so the rents are built into the contract for the next 10 years. I would only sell in year 10 if I can get the lease renewed and the market was hot for a potential trade up position into another property. If I really wanted to pay down the equity I could do so at anytime by writing a check as opposed to the slow pay down appreciation that @Joe Villeneuve pointed out with a traditional loan. In my scenario the equity (value) is increased because of the guaranteed rent increases.
Even better, and if you pay down the mortgage, all you're doing is adding cost to your property.
1 Reply
Henry ClarkPro Member
Developer · Member since 2020 · 4k+ posts · 4k+ votes
3y
Lunch at the beer brewery. My thinking might be off . Our contractors wife Sandy says hello.
Wait lunch just came. I’ll get back to my post in a second. Lobster is getting cold.
4 Reply
Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @John M.:

I should point out in my particular deal that this is a commercial property so the rents are built into the contract for the next 10 years. I would only sell in year 10 if I can get the lease renewed and the market was hot for a potential trade up position into another property. If I really wanted to pay down the equity I could do so at anytime by writing a check as opposed to the slow pay down appreciation that @Joe Villeneuve pointed out with a traditional loan. In my scenario the equity (value) is increased because of the guaranteed rent increases.
I see, the way I approach this problem is analyzing the amortization curve/table and comparing if and if not I add principal and guess-estimates the appreciation curve.

So when I do IO, I could do IO in the appreciation area as well, but then I would mimic the amortization table of 30YFRM 3-4% rate scenario, if the number is doable I may take the IO loan. Eg: adding 400 bucks a month is not a problem.

TBH, IO loan compare with 6,7,8,9,10 % 30YFRM doesnt have much difference in amortization curve ; so I may even go for IO if there's a lender can do IO for 4% then add principal payment to mimic the equity curve of 3-4% rate.
When I do everything right, for example, my equity LTV at year 10 would be 60-80%.

Of course it all depends on how your math brain works.

This is why I am not afraid of interest rate changes.
1 Reply
Henry ClarkPro Member
Developer · Member since 2020 · 4k+ posts · 4k+ votes
3y
Ok let me understand. Interest only 4.99% for 10 years.
we do self storage, country subdivisions and contractor flex this year.
The last self storage deal I set my brother up. 25% down $310k. $1.3mm loan. His banker who just left screwed up. He got 4% fixed for 20 years versus 5 year balloon.

For the bank they had CBRE appraise at $2.4mm at completion. No customers. 1 year later remarried and moving to Washington star. Put up for sale at $3mm which is at a 7% cap. He is 50% occupancy in one year.
So let’s say we did your 10 year at 4.99%.
He has $3mm less $1.3mm equity. Yes it’s up for sale and hasn’t closed. If he were to keep at 4.99% and pay no principal down. He would still realize his equity at the end of 10 years.
Say inflation is at 7% over the 10 years versus the 4.99%. So we are paying the interest and principal off with cheaper dollars. His captured equity is increasing due to inflation.
What’s the answer? Interest only or pay off the PI?

Forget that. What country am I in? One beer to many.
2 Reply
Henry ClarkPro Member
Developer · Member since 2020 · 4k+ posts · 4k+ votes
3y
I did have to many beers. Just one. Equity is $3mm possibly versus his $310k cash in.
0 Reply
Henry ClarkPro Member
Developer · Member since 2020 · 4k+ posts · 4k+ votes
3y
His loan is $1.3mm total less $310k down.
0 Reply
V.G JasonPro Member
Investor · Member since 2022 · 3k+ posts · 3k+ votes
3y
Quote from @Carlos Ptriawan:

Quote from @John M.:

I should point out in my particular deal that this is a commercial property so the rents are built into the contract for the next 10 years. I would only sell in year 10 if I can get the lease renewed and the market was hot for a potential trade up position into another property. If I really wanted to pay down the equity I could do so at anytime by writing a check as opposed to the slow pay down appreciation that @Joe Villeneuve pointed out with a traditional loan. In my scenario the equity (value) is increased because of the guaranteed rent increases.
I see, the way I approach this problem is analyzing the amortization curve/table and comparing if and if not I add principal and guess-estimates the appreciation curve.

So when I do IO, I could do IO in the appreciation area as well, but then I would mimic the amortization table of 30YFRM 3-4% rate scenario, if the number is doable I may take the IO loan. Eg: adding 400 bucks a month is not a problem.

TBH, IO loan compare with 6,7,8,9,10 % 30YFRM doesnt have much difference in amortization curve ; so I may even go for IO if there's a lender can do IO for 4% then add principal payment to mimic the equity curve of 3-4% rate.
When I do everything right, for example, my equity LTV at year 10 would be 60-80%.

Of course it all depends on how your math brain works.

This is why I am not afraid of interest rate changes.
This is probably the only way to do it in area where it makes sense too with appreciation. The first 10 years are minute equity, 8-10% but that 8-10% is more than nothing. The nothing doesn't cover your seller fees if you sell even off of a 5-6% appreciation, and god forbid you had any tenant issues or capex concerns. Finding low IO and then paying down equity.

Who offers 3-5% IO in today's world?
2 Reply
Hadar OrkibiPro Member
Rental Property Investor · USA / NZ · Member since 2016 · 1k+ posts · 812 votes
3y
@V.G Jason IO is NOT Dumb. It is required in some situations.
for example, in a heavy list Multifamily deal, when the first 1-2 years, the property will cashflow less.
it is also helpful when one builds a portfolio in a high-growth market when the plan is to sell half and keep the other half with no or low leverage.
3 Reply
Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @V.G Jason:

Quote from @Carlos Ptriawan:

Quote from @John M.:

This is why I am not afraid of interest rate changes.
This is probably the only way to do it in area where it makes sense too with appreciation. The first 10 years are minute equity, 8-10% but that 8-10% is more than nothing. The nothing doesn't cover your seller fees if you sell even off of a 5-6% appreciation, and god forbid you had any tenant issues or capex concerns. Finding low IO and then paying down equity.

Who offers 3-5% IO in today's world?

That's the key there, first, 10 years is "minute" equity. Actually, if you think about it, 10Y IO 7% is not really that much different from 7% 30YFRM, they're all equally *bad* rates to invest in anyhow.

For a 300K loan, with 30YFRM on the first 10 years, the first ten years your principal is about $250/mo and interest portion $1750-ish, but on the tenth year, amortization table portion of interest is still $1450-1500 anyway. It's still bad. For IO, interest portion is constant $1750, not much different.

So how do I utilize the IO:
1. You make an additional principal that's double the 7%, so you add $500 every month
2. In the contrary, I prefer to invest in a place where location appreciation should be greater than 500*12=$6,000 a year.
3. Even better if your leverage ratio is 1:2 instead of traditional 1:4. If your leverage is 1:2 ; by adding principal, on the 10th year your equity is almost 90% LTV.

If location is not appreciating, then I'd rather put the money into 5% 1 year riskless CD.
1 Reply
Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
My problem is really not an IO, but this:

1. In low QE environment, adjustable money-growth and average home appreciation is about 5% to 6% in good area.
2. In high rate environment like today, there is CD program offering 5% year.
3. In higher QT environment, home appreciation is slower than QE era, lets say it is equal to inflation rate, lets say 3% to 4%.
4. we could re-invest into real estate any time anyway, if there's uptick in appreciation and chance to make money.
So before I found a true deal in real estate, putting money into CD seems no brainer.

We now having 40 year mortgage program with IO on the first 10 year, if we keep long term prospective, that could be a cool benefit especially for house that experienced major price crash. The IO product is more interesting these days esp if rate is lower.
2 Reply
Allan C.
Rental Property Investor · Member since 2018 · 826 posts · 810 votes
3y
@John McKee I have found 30 year IO products and think they are great. Most people who dislike IO are not account for Net Present Value of money.
Let’s say hypothetically your goal is to have a property fully paid off in 30 years. I would rather pay the full principal at one time in year 30 instead of monthly over 30 years. Doesn’t matter if the principal is $100k or $1M, as an investor i would like to think my opportunity cost of growing that capital will beat the loan interest rate.
This also shows the value of developing a strategy - you can define your end goal and the best path to reach it.
3 Reply
Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @Allan C.:

@John McKee I have found 30 year IO products and think they are great. Most people who dislike IO are not account for Net Present Value of money.
Let’s say hypothetically your goal is to have a property fully paid off in 30 years. I would rather pay the full principal at one time in year 30 instead of monthly over 30 years. Doesn’t matter if the principal is $100k or $1M, as an investor i would like to think my opportunity cost of growing that capital will beat the loan interest rate.
This also shows the value of developing a strategy - you can define your end goal and the best path to reach it.

yeah, and I can payoff 30YFRM in 10 years too. Even with IO. The key is appreciation.
0 Reply
Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
3y
Quote from @Carlos Ptriawan:

Quote from @Allan C.:

@John McKee I have found 30 year IO products and think they are great. Most people who dislike IO are not account for Net Present Value of money.
Let’s say hypothetically your goal is to have a property fully paid off in 30 years. I would rather pay the full principal at one time in year 30 instead of monthly over 30 years. Doesn’t matter if the principal is $100k or $1M, as an investor i would like to think my opportunity cost of growing that capital will beat the loan interest rate.
This also shows the value of developing a strategy - you can define your end goal and the best path to reach it.

yeah, and I can payoff 30YFRM in 10 years too. Even with IO. The key is appreciation.
Why would you pay it off faster?
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