Debt
Interest-Only: What It Flatters and What It Does Not
An IO period improves every number a borrower looks at and none of the numbers that determine whether you can refinance.
Interest-only periods are common, useful and routinely misread. They improve the metrics you look at during the hold and change nothing about the position you are in when the loan matures.
What improves
Coverage, immediately. On a loan where the amortizing payment produces 1.30 times coverage, the interest-only payment on the same loan might produce 1.59. Cash flow improves by the principal you are not paying, and cash-on-cash return rises with it, often by two or three percentage points.
Loan sizing improves too, if the lender allows it. A lender testing coverage against the interest-only payment will lend materially more than one testing against the amortizing constant, commonly twenty percent more. Most lenders size on the amortizing number and grant interest-only separately, so treat interest-only sizing as the optimistic case rather than the quote.
What does not improve
The balance. That is the whole point and it is the thing people forget. During an interest-only period your loan balance sits exactly where it started. When you sell or refinance, you owe what you borrowed.
So the leverage you exit with is entirely a function of what happened to value. If cap rates widened, your loan-to-value at sale is higher than at purchase, and the refinance you were counting on may not be available at the proceeds you assumed.
The cliff
The number worth putting in front of yourself is the coverage ratio on the day the interest-only period ends. If the deal produces 1.59 times during interest-only and 1.30 after, you need to be comfortable operating at 1.30, because that is the deal, and the earlier figure was a financing feature rather than a property characteristic.
Where this goes wrong is when the interest-only period was doing the work of making a thin deal look adequate. Model both, always, and make the decision on the amortizing number.
See both: every debt model on this site shows the interest-only payment and the amortizing payment side by side, with a full coverage and amortization schedule.
Related notes
How to read this. These are working notes. Figures come from public reporting and from the models on this site, and market conditions change, check anything time-sensitive against the source before you rely on it. Nothing here is investment, tax or legal advice, and no note is a substitute for diligence on a specific property.
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