Discover The Advantage: What Is a Non-Amortizing Loan?
A non-amortizing loan is a type of loan for which payments on the principal are made by lump sum. As a result, the value of the principal does not decrease at all over the life of the loan. Popular types of non-amortizing loans include interest-only loans or balloon-payment loans.
Key Takeaways:
- A non-amortizing loan is a type of loan for which payments on the principal are paid in a lump sum.
- The value of the loan principal does not decrease over the life of the loan.
- Interest-only and balloon-payment loans are popular types of non-amortizing loans.
Understanding Non-Amortizing Loans
A non-amortizing loan has no amortization schedule because the principal is paid off in a single lump sum. Non-amortizing loans stand out because most standard loans come with an amortization schedule that determines the monthly principal and interest payments.
Non-amortizing loans require their principal to be paid back in one lump sum instead of through regular installments and typically feature short durations and high-interest rates.
Non-amortizing loans typically come with higher interest rates because they normally are unsecured and have lower installment payments, which lowers the cash flow to the lender. Since they lack a conventional amortization schedule, non-amortizing loans can be more complicated for lenders. If installment payments are made, each must be tracked and recorded separately from the principal. For balloon payments, the lender must calculate total interest to be collected with the lump sum.
Types of Non-Amortizing Loans
Balloon mortgages, interest-only loans, and deferred-interest programs are examples of non-amortizing loan products that borrowers may consider. These loans don’t require any principal payments in installments during their life.
Some non-amortizing loans may involve just the interest payments made in installments, while others defer both principal and interest. Usually short-term in nature, these loans pose a higher risk for lenders due to deferred payment obligations. They generally are not qualified loans, a status that would allow them to receive specific protections and be resold in secondary markets.
How Do Borrowers Use Non-Amortizing Loans?
Non-amortizing loans are frequently used in land contracts and real estate development financing. In these cases, borrowers generally have limited immediate collateral, particularly when constructing a property on undeveloped land.
A non-amortizing loan provides borrowers a specific period to complete the property, after which they can potentially refinance or secure a takeout loan with more favorable terms, using the newly constructed property as collateral.
These loans gained popularity before the 2008 financial crisis when dubious mortgage industry practices aimed at attracting consumers to unaffordable mortgages were widespread.
Special Considerations
Non-amortizing loans can serve borrowers in specific scenarios. These loans offer a defined timeframe for repaying the principal without needing monthly installment payments. This is beneficial for borrowers planning to save during the loan term or those anticipating an increase in their monthly income.
Related Terms: Interest-only loan, Balloon-payment loan, Amortization schedule, Takeout loan.
