Interest-only period is the span of a commercial real estate loan during which the borrower pays only interest and no principal. Payments are lower because the balance does not amortize, which raises free cash flow and debt service coverage. It is common on CMBS, agency, and bridge loans, and either covers part of the term or the full term.
How Does an Interest-Only Period Work?
An interest-only period works by suspending principal repayment for a set number of months, so the borrower pays only accrued interest and the loan balance stays flat. When the period ends, the loan begins amortizing on a schedule, usually 25 or 30 years, and the payment steps up to cover both principal and interest. The full balance still comes due at maturity.
Per CMBS.loans, interest-only periods on conduit loans are typically 36 or 60 months, after which the loan amortizes on a 30-year schedule. Because no principal is paid during the period, the balance at conversion is the same as at origination, which produces a payment increase the borrower must underwrite in advance.
Structure | Description |
Partial-term interest-only | Interest-only for the first 1 to 5 years, then amortizing for the remainder |
Full-term interest-only | Interest-only for the entire term, with the full balance due as a balloon at maturity |
Amortizing (no IO) | Principal and interest paid from the first payment, balance declining throughout |
Per CMBS.loans, most conduit loans are partially amortizing rather than fully amortizing, so the loan balloons at maturity regardless of the interest-only structure. The interest-only period changes the payment profile during the term, not the fact that a large balloon must be refinanced or repaid at the end.
Why Interest-Only Periods Matter
Interest-only periods matter because they lower debt service, which raises the debt service coverage ratio a lender uses to size the loan. A higher coverage ratio lets a borrower qualify for more proceeds on the same net operating income. That is why sponsors request interest-only structure: it is a lever on loan size and early-year cash flow, not just on the monthly payment.
Per ValueXpress, on a $2,000,000 property producing $100,000 of net cash flow, an interest-only structure at a 5% rate yields $75,000 of debt service and a 1.33x coverage ratio, while amortizing the same loan over 30 years raises debt service to roughly $96,000 and drops coverage to about 1.05x. The interest-only period is what lets the loan clear a 1.25x coverage minimum.
The quotable point for an operator: an interest-only period raises early cash flow, but it defers no principal reduction, so the borrower must underwrite the higher post-conversion payment before signing, not after.
Example
A borrower takes a $10,000,000 CMBS loan at a 6% fixed rate with a 10-year term, structured as 3 years interest-only followed by amortization on a 30-year schedule. The comparison below shows the annual payment before and after conversion.
Item | Calculation | Result |
Loan amount | Given | $10,000,000 |
Interest rate | Given | 6% |
Interest-only annual payment | 6% x $10,000,000 | $600,000 |
Amortizing annual payment (30-year) | Standard amortization on $10,000,000 at 6% | Roughly $719,500 |
Annual payment increase at conversion | $719,500 minus $600,000 | Roughly $119,500 |
During the 3-year interest-only period the borrower pays $600,000 a year, or $50,000 a month. When the loan converts to a 30-year amortizing schedule, the monthly payment on $10,000,000 at 6% is about $59,955, or roughly $719,500 a year. That is a payment jump of about $119,500 per year, near a 20% increase, which the property's cash flow must absorb the moment the interest-only period ends.
Variations and Edge Cases
Interest-only periods are not uniform: length, conversion terms, and lender appetite shift with the loan type, the sponsor, and the property. The table below covers the variants an operator should confirm before signing a term sheet.
Variant | Treatment |
Full-term interest-only | Whole balance is due as a balloon; no amortization cushions the refinance |
Partial-term interest-only | Payment steps up mid-term; the higher payment must be stress-tested |
Bridge loans | Often fully interest-only by design, since repayment comes from a takeout, not amortization |
Agency loans | Interest-only usually reserved for lower-leverage, well-qualified borrowers |
Amortization term vs loan term | A 10-year loan on a 30-year schedule still balloons at year 10 |
The most common mistake is underwriting only the interest-only payment. A property that comfortably covers debt service during the interest-only period can fall below a lender's coverage minimum once the loan begins amortizing, which can strand a refinance. The post-conversion payment should be the underwriting basis, not the introductory one.
Interest-Only Period vs Amortization
Interest-only period is often confused with amortization, and both describe how a loan is repaid, but they are opposites. An interest-only period is a span when the borrower pays only interest and the balance stays flat. Amortization is the process of paying down principal over time so the balance declines with each payment.
The practical difference is what happens to the balance. During an interest-only period the balance does not move, so payments are lower but no equity is built through paydown. Under amortization the balance falls each month, so payments are higher but the borrower reduces the balloon owed at maturity. Most commercial loans combine the two, running interest-only first and amortizing after.
Frequently Asked Questions
What is an interest-only period on a commercial loan?An interest-only period on a commercial loan is a span during which the borrower pays only interest and no principal, so the balance stays flat. It lowers the payment, raises debt service coverage, and is common on CMBS, agency, and bridge loans, covering either part of the term or the full term.
How does an interest-only period affect DSCR?An interest-only period raises the debt service coverage ratio because it lowers debt service. Per ValueXpress, a loan that produces a 1.05x coverage ratio when amortized over 30 years can produce about 1.33x when structured interest-only, which lets a borrower qualify for larger loan proceeds on the same net operating income.
What happens when an interest-only period ends?When an interest-only period ends, the loan converts to an amortizing schedule and the payment steps up to cover both principal and interest. On a $10,000,000 loan at 6% converting to a 30-year schedule, the annual payment rises from $600,000 to roughly $719,500, a jump near 20%.
How long is a typical interest-only period?A typical interest-only period on a CMBS conduit loan is 36 or 60 months, per CMBS.loans, after which the loan amortizes on a 30-year schedule. Bridge loans are often interest-only for the full term, while agency loans reserve interest-only for lower-leverage, well-qualified borrowers.
Related Terms
Debt Service Coverage Ratio
Permanent Loan
Bridge Loan
Net Operating Income
Loan to Value Ratio