Interest only vs repayment commercial mortgages

An interest-only commercial mortgage is a loan on which you pay only the interest each month, leaving the full balance outstanding to be repaid at the end of the term, while a capital and interest repayment mortgage clears both the interest and a slice of the loan each month so the debt is gone by the end. Choosing between the two is one of the most important decisions on any commercial mortgage, because it shapes your monthly payment, your cash flow and how much you owe at the finish. We arrange both as an introducer rather than a lender, and the right choice depends on what you are doing with the property.

This guide explains how an interest-only commercial mortgage works, how it compares with a repayment loan, what each costs, who is eligible for interest-only, and how to decide which suits a warehouse or industrial unit. We have written it for owner-occupiers buying premises to trade from and for investors holding property for rental income, because the two often pull in different directions on this question. Throughout we set out the trade-offs plainly, since the cheaper monthly payment of interest-only carries a balance you must still repay, and the right answer is the one that fits your plan for the building.

Can a commercial mortgage be interest only?

Yes, a commercial mortgage can be interest only, and it is a widely available and entirely standard option, particularly for investment property. On an interest-only commercial mortgage you pay the lender only the interest charged on the loan each month, and the full capital balance remains outstanding throughout the term. The monthly payment is therefore lower than on a repayment loan of the same size, because you are not repaying any of the capital, which preserves cash flow during the life of the loan.

The trade-off is that the entire loan balance is still owed at the end of the term, so the lender will want to know how you intend to repay it. Common repayment routes, often called the exit, are selling the property, refinancing onto a new commercial mortgage, or accumulating funds to clear the balance. A lender granting an interest-only loan assesses that exit carefully, because unlike a repayment loan there is no built-in mechanism steadily reducing the debt, and the full amount must be found in one go at the finish.

Interest-only is most readily available on commercial investment mortgages, where the rental income comfortably covers the interest and the investor's strategy is to hold the asset and refinance or sell in due course. It is also available to owner-occupiers, though some lenders prefer a repayment basis or a shorter interest-only period for owner-occupied loans, because they like to see the trading business steadily reducing the debt. The availability and the rate depend on the lender, the loan to value and the strength of the case, which is exactly where matching to the right lender pays off.

How does interest-only compare with a repayment commercial mortgage?

The core difference is what happens to the balance. On a repayment commercial mortgage, each monthly payment covers the interest plus a portion of the capital, so the balance falls steadily and the loan is fully cleared by the end of the term, leaving you owning the property outright with no debt. On an interest-only commercial mortgage the balance stays the same throughout, so at the end of the term you still owe the full amount you originally borrowed and must repay it through sale, refinance or saved funds.

This drives the difference in monthly cost. Because a repayment loan is chipping away at the capital, its monthly payment is higher than an interest-only loan of the same size at the same rate. The gap can be substantial early in a long term, when most of a repayment loan's payment is interest but a slice still goes to capital. Interest-only keeps the monthly outgoing as low as the rate allows, which is why investors often choose it to protect rental cash flow and keep the surplus working elsewhere.

Over the whole life of the loan, though, repayment is usually cheaper in total interest paid, because the balance the interest is charged on shrinks each year, whereas on interest-only the interest is charged on the full balance every year until the end. So the decision is a trade between lower monthly cost and cash flow now, which favours interest-only, and lower total cost and outright ownership later, which favours repayment. We model both side by side on the actual numbers, because the right answer depends entirely on your plan for the property.

How much does a commercial interest-only mortgage cost?

The cost of an interest-only commercial mortgage is driven by the interest rate, the loan size and the term, and because no capital is repaid, the monthly payment is simply the interest on the full balance. The rate itself is usually quoted as a margin over a reference rate such as the Bank of England base rate or a swap rate, so it moves with the wider market. On a two hundred thousand pound interest-only loan at, say, seven percent, the annual interest is fourteen thousand pounds, or roughly one thousand one hundred and sixty-six pounds a month, with the full two hundred thousand still owed at the end.

Compared with a repayment loan of the same size, the interest-only monthly payment is lower, but the total paid over the term can be higher because the interest is charged on the undiminished balance throughout. There are also the usual costs around any commercial mortgage to account for: an arrangement fee, commonly one to two percent of the loan, a valuation, legal work on both sides, a broker fee, and any early repayment charge if you exit the deal early. We always set out the full cost over the expected term so you can compare interest-only and repayment fairly rather than on the headline monthly figure alone.

The rate on an interest-only commercial mortgage is not automatically higher or lower than on a repayment loan; it is set by the same factors, namely the loan to value, the strength of the borrower or the rental income, and the quality of the property. What changes the overall economics is the absence of capital repayment, which lowers the monthly cost but leaves the balance to be dealt with at the end. Because the balance does not reduce, the strength of your repayment plan matters as much to the true cost as the rate, since a forced refinance at a worse rate later can outweigh the monthly saving now.

Who is eligible for an interest-only commercial mortgage?

Eligibility for an interest-only commercial mortgage rests mainly on the strength of the repayment plan and the quality of the security. A lender granting interest-only wants confidence that the full balance can be repaid at the end of the term, so it looks for a credible exit: a property likely to hold or grow its value for a sale, rental income strong enough to support a refinance, or evidence of funds being built to clear the debt. The clearer and more robust that exit, the more comfortable a lender is offering interest-only.

Investors are the most natural fit, because rental income that comfortably covers the interest, combined with a strategy of holding and eventually selling or refinancing, matches the interest-only model well. The lender tests the income through an interest coverage ratio, typically wanting the rent to cover the interest by around 1.25 to 1.45 times, and a strong lease to a reliable tenant makes interest-only straightforward to secure. The loan to value also matters: a lower loan to value gives the lender more comfort that a future sale or refinance will clear the balance.

Owner-occupiers can also obtain interest-only, though some lenders prefer repayment or a part interest-only structure for premises a business trades from, because they like to see the debt reducing alongside the business. Where an owner-occupier wants interest-only, perhaps to keep early payments low while the business grows, we look for lenders comfortable with that approach and a sound exit. Because eligibility and appetite vary so much between lenders, matching the case to the right one is central to securing interest-only on sensible terms, which is the work we do as an introducer.