Board Topic: Interest Only
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Interest Only

Posted by: Lee Nov 10 2003, 10:59 AM
I have a client who is interested in financing an existing 10 unit multifamily property. He suggested that we utilize an interest only program. The purchase of the property will be $950,000, he has $250,000 for cash down, so that will get him at $750,000. Should we put him on a 1-6mth libor ARM interest only program or a 10yr fixed and an interest only for 1-3yr?

Obviously I am new to the commercial finance industry, so any suggestions would be greatly appreciated. I Love the board, it has been extremely helpful.

Thank you,
Lee

Posted by: loanuniverse Nov 10 2003, 06:10 PM
Lee:

First let me do a little math adjustment. $950,000 - $250,000 = $700,000 or 73.7% loan to value using the purchase price. The problem with doing an interest only loan is that the amortization helps the lender by improving the collateral position from day one. When something like this proposal comes up, a few questions will come up in my head. Depending on the answers to those questions, and how comfortable you feel with those answers then you can decide if you want to go ahead and do the loan or maybe propose a different structure. Those questions are:

1- Why does the customer want interest only? Which is not the normal kind of structure for these deals.

2- Can the property support a normal amortization schedule? In other words, the interest only structure is not because of lack of debt service coverage.

3- The quality of the customer and the overall relationship. If the borrower owns 15 of those buildings and is worth millions in adjusted net worth, then it is more appetizing.

4- The quality of the property itself.

5- If you are doing an interest only loan on a stabilized property {one that is fully occupied and not under construction or renovation}, the larger the cushion the better. Can this be improved?


Regarding your question about pricing and structure, that would be dependent on the institutionís target profitability. A lender likes variable instead of fixed since it eliminates interest risk, and would much rather have prime be the base rate rather than LIBOR. BTW, there are some other options that you might consider, when you structure the deal. You can structure it at a floating rate interest only for 24 months, with a conversion at the end of the 24 months to a fixed rate using the base rate prevailing at the time. The conversion would be automatic and at no charge, but throw in an option that allows him to convert earlier, but with a conversion fee of 50 basis points. This will give him some flexibility and gets you some extra fee income down the line. Moreover, with interest rates as low as they are, the borrower would want to convert sooner than later.

Frankly, the structure can be as different as there are lenders in your town.

Hope this helps.

Posted by: Lee Nov 10 2003, 08:45 PM
I caught that calculation error when I posted it. But thanks for your prompt response. It was really helpful.

Lee
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