What Is an Interest-Only Loan in Commercial Real Estate?

An interest-only loan in commercial real estate allows the borrower to pay only the interest on the loan for a set period, typically one to five years, without reducing the principal balance. Monthly payments during the interest-only (IO) period are significantly lower than fully amortizing payments, which makes IO structures popular for acquisitions, value-add plays, and transitional properties where the borrower expects income to grow over time.

How Interest-Only Payments Work

The math is simple. During the IO period, the borrower pays only the interest accruing on the outstanding loan balance each month:

Monthly IO Payment = Loan Amount x (Annual Interest Rate / 12)

On a $5 million loan at 6.5%, the monthly interest-only payment is $27,083. The same loan on a 25-year amortization schedule would require approximately $33,760 per month in principal and interest. That difference of roughly $6,677 per month, or $80,000 per year, goes directly to the borrower's cash flow during the IO period. Use the commercial mortgage calculator to compare IO and amortizing payments for any loan scenario.

Interest-Only vs. Fully Amortizing: Side by Side

Which CRE Loan Types Offer Interest-Only

Not every loan program includes IO as an option. Here is where IO is commonly available:

When Interest-Only Makes Strategic Sense

IO is not free money. It is a cash flow management tool that works best in specific situations:

Value-add acquisitions. You buy a property with below-market rents, plan renovations, and expect NOI to increase over 18 to 36 months. IO keeps debt service low during the repositioning period when the property is not generating stabilized income. Once rents increase, the property can support amortizing payments or the borrower refinances into permanent debt.

Lease-up periods. A recently developed or repositioned property that is not yet fully leased benefits from IO while occupancy ramps. Paying full amortizing debt service on a 60% occupied building strains cash flow unnecessarily.

Short-term hold strategies. If the business plan calls for selling within three to five years, amortization provides limited benefit. IO maximizes cash-on-cash returns during the hold and the principal balance difference at sale is relatively small compared to the total transaction.

Bridge-to-permanent transitions. Bridge loans are almost universally IO because they are designed as short-term capital while the borrower executes a business plan before refinancing into permanent, amortizing debt.

When Interest-Only Creates Risk

IO is not appropriate for every deal. The risks include:

Payment shock. When the IO period expires and the loan converts to amortizing payments, the monthly payment increases substantially. On a 10-year CMBS loan with 3 years of IO and 30-year amortization, the jump at year 4 can be 20% to 30%. If the property's NOI has not increased enough to absorb the higher payments, the borrower faces a DSCR problem.

Maturity risk. Because no principal was paid down during the IO period, the outstanding balance at maturity is higher than it would have been with amortization. This means the borrower needs a higher property value, lower rates, or additional equity to refinance. If the market has softened, this becomes a serious problem.

Negative equity accumulation. The borrower builds no equity through debt reduction during the IO period. If property values decline, the borrower may find themselves underwater sooner than they would have been with an amortizing loan.

Negotiating Interest-Only Terms

IO is often negotiable, especially on CMBS and bank loans. A few factors that influence whether a lender will grant IO and for how long:

• DSCR cushion. Lenders are more willing to grant IO when the property's DSCR on an amortizing basis is already strong (1.30x or higher). This shows the property can handle amortizing payments even without the IO benefit.
• LTV. Lower loan-to-value (LTV) ratios give lenders comfort that the lack of principal paydown is offset by a larger equity cushion. Expect IO to be harder to negotiate above 70% LTV.
• Sponsor strength. Experienced sponsors with strong track records and liquidity get IO more easily. Lenders trust they will execute the business plan and handle the transition to amortizing payments.
• Property quality. Well-located, institutionally maintained properties with stable tenancy are more likely to receive IO. Lenders see less risk in the property holding value without principal reduction.

Interest-Only in the Current Market

IO availability fluctuates with market conditions. In periods of rising interest rates, lenders become more conservative about granting IO because higher rates mean larger payments when amortization begins. In competitive lending environments, IO is used as a sweetener to win deals. Borrowers should expect IO terms to be tighter when capital markets are stressed and more generous when lenders are competing for loan volume.

For CMBS loans specifically, full-term IO (interest-only for the entire 10-year loan term) was common in 2019 to 2021 but has become more selective. Partial IO of one to three years remains widely available for stabilized properties with strong fundamentals.

Related Terms

Understanding IO connects to several other CRE financing concepts:

• Amortization is the opposite of IO: the gradual repayment of principal over the loan term.
• Balloon payment is the remaining principal balance due at maturity, which is larger with IO because less (or no) principal has been paid down.
• DSCR measures the property's ability to cover debt service. IO improves DSCR during the IO period but the metric must be evaluated on an amortizing basis for long-term viability.
• NOI is the income figure that determines whether a property can support both IO and amortizing payments.
• Cash-on-cash return is higher during IO periods because lower debt service means more cash flow to equity.

Frequently Asked Questions