Amortized vs Interest Only

IN THIS GUIDE

What is an amortized loan?

An amortized loan is a loan that follows an amortization schedule of equal monthly payments. The loan’s balance will be paid in full by the maturity date.

How do lenders calculate the monthly payment of an amortized loan?

Lenders calculate the monthly payment using an the excel function PMT. The excel function will produce an entire amortization schedule stating the beginning balance, total monthly payment, monthly interest payment, monthly principal payment, and the ending balance. The schedule runs till the ending balance states zero.

Monthly Payment = PMT (Interest Rate / Annual Payments, Total Payments, Loan Amount)

Example

An investor is looking to acquire 10 properties and is requesting a loan amount of $1,500,000. The lender offers the investor a 10-year loan at a 4.55% interest rate that meets his requested loan amount.

Monthly Payment = $15,581.94

Monthly Payment = PMT (.0455 / 12, 120, $1500000)

Amortization Schedule

Month

1

2

3

120

Beginning Balance

$1,500,000.00

$1,490,105.56

$1,480,173.60

$15,523.08

Monthly Payment

$15,581.94

$15,581.94

$15,581.94

$15,581.94

Monthly Interest

$5,687.50

$5,649.98

$5,612.32

$58.86

Monthly Principal

$9,894.44

$9,931.96

$9,969.62

$15,523.08

Ending Balance

$1,490,105.56

$1,480,173.60

$1,470,203.99

$0.00

What is an interest only loan?

An interest only loan is a loan that allows the borrower to only pay the interest portion of the monthly payment. The principal is postponed till the end of the interest only period. At the end of the interest only period the borrower will have to make a balloon payment or lump sum payment to pay the principal balance.

How do lenders calculate the monthly payment of an interest only loan?

Lenders calculate the monthly payment using three variables: the interest rate, loan amount and the loans duration.

Monthly Payment = (Interest Rate * Loan Amount) / Loan Duration

Example

An investor is looking to acquire 10 properties and is requesting a loan amount of $1,500,000. The lender offers the investor a 10-year loan at a 4.55% interest rate that meets his requested loan amount.

Monthly Payment = $568.75

Monthly Payment = (4.55% * $1,500,000) / 120

Interest Only Schedule

Month

1

2

3

120

Beginning Balance

$1,500,000.00

$1,500,000.00

$1,500,000.00

$1,500,000.00

Monthly Payment

$568.75

$568.75

$568.75

$568.75

Monthly Interest

$568.75

$568.75

$568.75

$568.75

Monthly Principal

$0.00

$0.00

$0.00

$1,500,000.00

Ending Balance

$1,500,000.00

$1,500,000.00

$1,500,000.00

$0.00

How do investors and borrowers pay off an interest only loan?

The borrower can either pay the entire principal at the end of the interest only loan with a lump sum payment / balloon payment, refinance or sell the properties.

What are the advantages and disadvantages of an interest only loan?

Advantages: smaller monthly payments, increased cash flow, principal payment is deferred, larger profit margins, and more cash to cover expenses. Disadvantages: no equity built up in the properties, lump sum payment at the end of the loan, monthly payment increases significantly after interest only period ends, higher probability of default and is considered high risk.

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