Understanding Loan Interest

How Is Interest Calculated?

Whilst interest is frequently the largest and most significant cost to consider, it is also the least straightforward – The way interest is calculated will vary depending on both the lender selected and the type of specialist finance being applied for, which is often confusing for borrowers new to the specialist finance space.

Whilst the team at Pure Structured Finance will always answer any questions you have regarding loan terms, understanding the benefits and drawbacks of each type of interest will help you to select a product and make your broker aware of your preferences upfront, ensuring that you get the right loan terms straight away.

Interest-Only Repayment

‘Interest-Only’ repayment typically refers to long-term financing options (such as BTL and Commercial Mortgages), where borrowers receive an advance of funds at the start of the loan term, then make regular (typically monthly) payments to cover the interest on this advance. At the end of the loan’s term, borrowers will repay the original amount borrowed, often in a single lump sum.

Compared to the ‘capital and interest’ structure more common to residential mortgages, interest-only repayment has a lower monthly cost. This maximises income from an investment property and keeps overheads down, allowing borrowers to extract the maximum return from a property during the loan term.

Retained/Deferred Interest

Most often associated with short-term bridging finance, retained (or deferred) interest involves the lender calculating the total interest payment at the outset of the loan, and ‘retaining’ it: Interest is deducted from the gross loan before the start of the term, reducing the ‘net’ amount received by the borrower.

Borrowers may select retained interest in cases where a property is not currently producing income; either due to being vacant, requiring works, or letting simply not being part of borrower strategy. In these cases, a monthly interest payment may not be feasible or be too much of a burden on cashflow.

Retained interest allows borrowers to manage their cashflow and repay both capital and interest in a lump sum at the end of the term, most often through refinancing or sale of the property. Facilities can also be ‘part-retained’, where a set number of months are retained and those subsequent are serviced. This allows borrowers time to get a property to a stage where it is producing regular income before starting monthly payments.

Serviced Interest

‘Serviced’ interest most commonly refers to bridging loans, and works in the same way as ‘interest-only’. Lenders provide a lump sum at the start of the term, with borrowers making regular payments to cover (or ‘service’) the interest on these funds, then repaying the initial advance at the end of the loan term. Whilst the way serviced interest is calculated and paid is the same an an interest-only mortgage, the uses of serviced bridging loans are very different.

Borrowers may choose to service interest on a bridging facility for two main reasons. First, if the property being purchased/refinanced is currently income-producing and servicing monthly interest is feasible, servicing will mean a smaller final repayment and lower overall cost than retained interest.

Second, because serviced interest is added to the loan during the term (rather than deducted from it as with retained interest), a serviced bridge provides a larger lump sum at the start of the loan term compared to other interest types, despite having the same overall Loan-To-Value (LTV).

Rolled-Up Interest

Like retained, rolled-up interest means does not require monthly interest payments, although the way it is calculated is slightly different. Rather than estimate interest at the start of the loan term, rolled facilities will add interest to the loan regularly, to be repaid in full at the end of the term.

Rolled interest is often favoured by lenders offering facilities where funds are not all released at the start of the term. An example of this is a development finance facility, where funding is split between an initial loan amount or ‘advance’ for the purchase of a site, and subsequent ‘drawdowns’ which cover the costs of works. Because the amount and timing of these drawdowns varies depending on how quickly the build progresses, accurately predicting the correct amount of interest to retain at the start of the term would be almost impossible.

Rolled interest is most popular among borrowers carrying out projects requiring additional funding during the term of the loan, and who don’t have regular cashflow to cover monthly interest costs. These borrowers will have a clear plan and exit, such as using finance to build a property then selling the completed unit, but limited cashflow during the loan term.

Need Help Finding Property Finance that Suits Your Needs?

If you’re not sure what type of loan would meet your requirements, or which lenders offer the best rates for your specific property, speak to a member of the team and let us structure a finance package around you and your specific needs.

Speak to our team today on 02080 579 178 or by requesting a call back.