Interest-only (IO) is a loan payment structure in which the borrower pays only interest, with no principal, for a specified period of the loan term. The period may cover the whole term (full-term IO) or part of it (partial IO), after which payments convert to amortizing amounts based on the remaining amortization schedule. Debt service falls; the balance does not.
Where are interest-only periods used?
IO structures are common across nearly all CRE loan types. Bridge loans are typically full-term IO, and permanent loans may offer one to five years of IO before amortization begins. Construction loans charge interest only on the amount drawn under the draw schedule.
The benefit is lower debt service during the IO period, which preserves cash flow for property stabilization, renovations or higher equity returns. The trade-off is that no principal is repaid, so the full loan balance remains outstanding.
What happens when the IO period ends?
During the IO period, DSCR is higher than it would be under an amortizing structure because debt service is lower. This “DSCR cliff” at the IO-to-amortization transition is a critical planning date: a property that passes its covenant comfortably during IO may fail the same test once amortization starts, especially if NOI has not grown enough.
Full-term IO means no paydown at all. The borrower owes the same balance at maturity that was borrowed at origination, so LTV depends entirely on property value appreciation. When evaluating IO terms, weigh the IO period length, the amortization schedule that follows and how the transition affects projected DSCR and cash flow.
How interest-only shows up in LoanBoss
LoanBoss tracks IO expiration dates as critical dates, models interest-only and partial IO amortization types, and calculates the debt service increase at each IO-to-amortization transition across the portfolio.
Frequently Asked Questions
What is the difference between full-term IO and partial IO?
Full-term IO runs for the entire loan term, so the balance never declines. Partial IO covers only the first part of the term, after which payments convert to amortizing amounts.
Why does DSCR fall when an IO period ends?
Debt service rises from interest alone to interest plus principal while NOI is unchanged. The same NOI covers a larger payment, so the ratio drops.
How long are IO periods on permanent CRE loans?
Permanent loans may offer one to five years of IO before amortization begins.
Related Terms
- Amortization
- Debt Service Coverage Ratio
- Construction Loan
- Draw Schedule
- Bridge Loan
- Interest-Only Expiry: Planning for the Amortization Cliff Across Your Portfolio
Part of the LoanBoss CRE Debt Glossary. For hedging-specific terms, see Pensford’s resources.
Sources
- LoanBoss CRE Debt Glossary