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.
- 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 Loan
A non-amortizing loan has no amortization schedule because the principal is paid off in a single lump sum. Non-amortizing loans are an alternative type of lending product as most standard loans involve an amortization schedule that determines the monthly principal and interest paid toward a loan each month.
Non-amortizing loans require their principal to be paid back in one lump sum rather than through regular installments and usually feature a short duration and a high-interest rate.
Generally, non-amortizing loans require higher interest rates because they are usually unsecured and offer lower installment payments, reducing the cash flow to the lender. Since they do not have a basic amortization schedule, non-amortizing loans can be more complex for a lender to structure. If any installment payments are made, they must be tracked individually and recorded separately from the principal. If a balloon payment is made, the lender must determine the interest to be collected with the lump sum when the payment is due.
Types of Non-Amortizing Loans
Balloon mortgages, interest-only loans, and deferred-interest programs are three general types of loan products that a borrower can look to for non-amortizing loan benefits. These loans do not require any principal to be paid in installment payments during the life of the loan.
Some loans may require only the interest payment in installments while others defer both the principal and interest. These loans are typically for a short duration, as the deferred payment results in higher risk for the lender. They are also not typically considered qualified loans, a status that would allow them to receive certain protections and be resold in the secondary market.
How Do Borrowers Use Non-Amortizing Loans?
Non-amortizing loans are commonly used in land contracts and real estate development financing. In these situations, borrowers typically have limited immediate collateral that can be used specifically when a residential or commercial building is being built on a tract of land.
A non-amortizing loan provides the borrower with a specific amount of time to build a property, after which the borrower can potentially refinance or obtain a takeout loan with better loan terms using the newly built property as the collateral.
These types of loans proliferated in the era preceding the financial crisis of 2008 when rogue mortgage industry practices became widely used to lure consumers to take on mortgages beyond their affordability.
Generally, non-amortizing loans can serve borrowers in special situations. These loans give a borrower a specified timeframe within which to repay the principal without the need for monthly installment payments. This can help borrowers who plan to save on their own over the life of the loan. These products can also target borrowers who have prospects for increasing their monthly income during the loan’s timeframe.