What is 'Non-Amortizing Loan'
A non-amortizing loan is a type of loan in which payments on the principal are not made until a lump sum is required. As a result, the value of 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.
BREAKING DOWN '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 since most standard loans involve an amortization schedule which determines the monthly principal and interest paid toward a loan each month.
Generally, non-amortizing loans require higher interest rates because they are usually unsecured, and they offer lower installment payments reducing the cash flow to the lender. Non-amortizing loans can be more complex for a lender to structure than standard loans because they do not have a basic amortization schedule. If any installment payments are made then they must be tracked individually and recorded separate from the principal. If a balloon payment is made then the lender must determine the interest to be collected with the lump sum when the payment is due.
Non-Amortizing Loan Products
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 since the deferred payment results in higher risk for the lender. They are also not typically considered qualified loans which allows them to receive certain protections and to be resold in the secondary market.
Non-Amortizing Loan Benefits
Non-amortizing loans are commonly used in land contracts and real estate development loans. Borrowers in these situations 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 they can potentially refinance or obtain a takeout loan with better loan terms using the newly built property as the collateral.
Generally, non-amortizing loans can serve borrowers in special situations. They do however usually require higher interest. These loans give a borrower a specified timeframe to repay the principal without requiring the stress of 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.