Is An Interest-Only Mortgage in Your Co-op's Best Interest?

There are situations in which an interest-only loan is the appropriate – and maybe only – solution. For example, at the time of their conversion, some buildings got stuck by their sponsor with very large loans at below-market interest rates. Replacing those loans at current market rates could place a substantial burden on shareholders, and amortization – the monthly repayment of a small portion of the outstanding loan principal in addition to the monthly interest – would make that burden even harder to bear.
 
Or maybe previous boards postponed repairs and upkeep for many years to avoid a maintenance increase. When the repairs become critical, the current board may be forced to borrow a lot more money. An interest-only loan may be the only affordable way to get the job done without creating hardship for many shareholders.

On the other hand, some financial advisors would argue that your new loan should include at least some amortization. Even a minimal amount of amortization guarantees that you will repay enough of your loan by its maturity date to cover the closing costs of your next refinancing. That ensures that the debt on your building will not grow over time solely because of refinancing costs.
 
A drawback of interest-only loans is that they saddle future shareholders with the entire burden of an ever-increasing amount of debt. Some board members argue that this growth in debt is irrelevant since most underlying mortgages are never paid off but, rather, are just rolled over indefinitely.

Other board members suggest that increases in apartment sales prices make their building more valuable and, hence, able to carry more debt. There is some truth to that idea, but it should be remembered that (current trends notwithstanding) real estate values do not always go up.

There also is a philosophical “fairness” argument in favor of amortization. Interest-only loans afford current shareholders all of the benefits of the new funds, as well as the lowest possible monthly payment. They get to ride in the new elevators, sleep under the new roof, and look out the new windows without having to pay their pro rata share of those improvements through monthly amortization. A more equitable arrangement would be to include amortization as part of every new loan so that every shareholder pays back some of the cost of each improvement.

It may be possible to structure a combination approach. Some lenders offer loans that are interest-only during a certain introductory period, after which amortization kicks in for the remainder of the loan term. This structure might allow boards to obtain the additional funds that they need now at a lower monthly payment, and then gradually raise maintenance over several years to the level necessary to cover monthly amortization.