Interest-Only Loans Have Become More Common

Interest-only loans are on the rise among balance sheet lenders as well as alternative lenders. This was one of the topline findings of the Meridian Capital Group Commercial Real Estate Survey.

Seventy-three percent of alternative lenders responding to the Meridian survey said that greater than 75 percent of their firm’s loan originations feature an interest-only component.

The percentage of interest-only bank loans—though not as high—is still impressive. Although 19 percent of balance sheet lenders stated that less than 25 percent of their loan originations feature an interest-only component, 25 percent said that between 25 and 49 percent fell into this category and 15 percent said that between 50 and 75 percent did. Remarkably, a full 40 percent of traditional lenders said that greater than 75 percent of their loan originations feature an interest-only component.

Although balance sheet lenders cede ground to alternative lenders when it comes to offering interest-only loans—62 percent of the bankers participating in the Meridian Capital Group survey said that nontraditional lenders are stronger when it comes to issuing interest-only loans—the gap is not as big as it once was.

A Positive Indicator

The rising incidence of interest-only loans reflects the strength of the economy. Wages are growing, employment is high, inflation remains low and the stock market—barring volatility from trade wars and tariffs—remains fundamentally solid. Investors are turning to interest-only loans to keep pace with rising property valuations and to free up cash for other opportunities. Interest-only loans are also the bread and butter of value-added investors, allowing them to renovate and upscale their properties. And, of course, they are especially attractive when interest rates, as they are now, are low.

At the same time, the ample cash that is flowing into the U.S. commercial real estate market and the competition for borrowers that has naturally ensued creates a situation where even balance sheet lenders are more willing to consider interest-only financing. At the same time, debt service coverage ratio (DSCR) and loan-to-value ratio remain healthy, indicating that lenders are still being highly selective about the transactions that consider for interest-only financing.

An Attractive Option

As attractive as an interest-only loans might be to owners and developers, the Meridian Capital Group survey showed it was not a deal breaker. When asked to identify the three most important factors when considering a lender to finance a stabilized property, borrowers named pricing, nonrecourse financing and LTV. Only 14 percent specified interest-only financing. Their response was virtually identical for transitional properties. Clearly, an interest-only loan—though more easily secured than before—is a nice-to-have and not a necessity for most investors.

The Meridian Capital Group Commercial Real Estate Survey was conducted online between November 13, 2018 and December 6, 2019 by Signet Research, an independent research company, and is based on the response of 1,849 industry professionals.