Interest only business loans: capital holidays, bullet repayments and where to find them

There are three common structures, and lenders use the terms loosely:

• Interest only for the whole term. You pay interest each month and repay all the capital at the end, usually from a sale, refinance or other funds. This is called a bullet repayment.
• Interest only period, then repayment. The loan starts on interest only for, say, six or twelve months, then switches to capital and interest over the rest of the term. Payments step up when the switch happens.
• Capital repayment holiday. Similar in effect: an agreed break from capital repayments, either at the start or, occasionally, during the loan.

A related idea is rolled up or retained interest, common on bridging and development finance, where interest is added to the loan or deducted upfront, so there are no monthly payments at all. The whole amount is repaid at the end.

• Property investors and developers with a clear sale or refinance plan.
• Businesses investing in a project that will generate cash later, such as a refurbishment or fit-out.
• Companies expecting a known inflow, such as a contract payment or asset sale.
• Seasonal businesses that need lower payments during quiet months.

Illustrative example only, not a quote

A company borrows £300,000 secured on a commercial property to refurbish a second unit it will let. It agrees a twelve month interest-only period while the work is done and tenants are found. During that year it pays interest only. From month thirteen the loan converts to capital and interest over the remaining term, by which point rent from the new unit helps cover the higher payment. If the company had chosen full repayment from day one, its monthly outgoings during the refurbishment would have been much higher.

With any interest only structure, the lender will want to know how the capital will be repaid. For bridging and development, this is the exit strategy, and lenders scrutinise it closely; our guide to bridging loan exit strategies covers what makes a credible exit. For term loans with an interest-only period, the question is whether the business can afford the higher payments once capital repayments begin.

Plan for things taking longer than expected: sales fall through, refinances get delayed, and projects overrun. Extensions are not guaranteed and can be costly.

Interest only reduces monthly payments but usually increases the total interest paid, because the balance stays higher for longer. When comparing offers, look at:

• Total cost over the life of the loan, not just the monthly payment.
• Arrangement and exit fees, which are common on bridging and development finance.
• Whether interest is serviced monthly, rolled up or retained, and how that affects the net amount you receive.
• Early repayment charges if your exit comes sooner than planned.

If the aim is lower payments over a long period, a commercial mortgage on a long term may achieve that on a repayment basis. Investors holding let property can compare commercial investment mortgages, where interest only options are sometimes available.