What is a non-amortizable loan?
A non-amortizing loan is a type of loan in which payments on principal are not made until a lump sum is required. Therefore, the capital value does not decrease at all during the term of the loan. Popular types of non-amortizing loans include interest only loans or lump sum loans.
Understanding the loan without amortization
A non-amortizable loan has no amortization schedule because the capital is repaid in a single payment. Another type of loan product is non-amortizable loans, since most standard loans involve an amortization schedule that determines the monthly principal and interest paid on a loan each month.
Non-amortizable loans require their principal to be repaid in one go rather than in regular installments and generally have a short term and a high interest rate.
Typically, non-amortizing loans require higher interest rates because they are generally unsecured and offer lower installments, which reduces cash flow to the lender. Since they do not have a basic amortization schedule, unamortized loans can be more complex to structure for a lender. If payments are made, they must be tracked individually and recorded separately from the principal. If a lump sum payment is made, the lender must determine the interest to be collected with the lump sum when the payment is due.
Types of non-amortizable loans
Balloon mortgages, interest only loans and deferred interest programs are three general types of loan products that a borrower can look for for unamortized loan benefits. These loans do not require any payment of principal in installments over the life of the loan. Some loans may only require payment of interest in installments, while others carry both principal and interest. These loans are usually short-term, as deferred payment carries higher risk for the lender. Nor are they generally considered to be qualified loans, a status that would allow them to benefit from certain protections and be sold on the secondary market.
How do borrowers use non-amortizing loans?
Unamortized loans are commonly used in land contracts and financing real estate development. Borrowers in these situations generally have an immediate limited guarantee which can be used specifically when a residential or commercial building is constructed on a plot of land. An unamortized loan gives the borrower a specific time frame to build a property, after which the borrower can potentially refinance or get a takeout loan with better loan terms using the newly built property as collateral.
Special considerations for non-amortizable loans
Generally, non-amortizing loans can be used by borrowers in special situations. These loans give the borrower a specific amount of time to repay the principal without having to endure the stress of monthly payments. This can help borrowers who plan to save for themselves over the life of the loan. These products can also target borrowers who have prospects of increasing their monthly income over the life of the loan.