Interest-Only Loan

An interest-only loan requires payments of interest alone for an initial period, typically five or ten years, after which the loan amortizes over the remaining term. DSCR lenders offer interest-only options widely because the lower payment lifts the ratio, often by 0.10 to 0.15.

Interest on $375,000 at 7.5% is about $2,344 a month, compared with $2,622 for the fully amortizing payment. Add $708 of taxes and insurance and $4,000 of rent produces a DSCR of 1.31 interest-only versus 1.20 amortizing. Nothing about the property changed.

The catch is the reset. When the interest-only period ends, the balance amortizes over the years that remain, so the payment jumps above what a 30-year amortizing loan would have charged from the start. Interest-only helps investors who will sell or refinance before the reset and hurts those who will not. Ask the lender whether it qualifies on the interest-only or the amortizing payment.

Further reading: Interest-Only Loan on Wikipedia.