October 29, 2019 | Last Updated on: August 16, 2023
An interest only loan is a loan in which the borrower only pays the interest payments on the loan amount over a pre-agreed period. At the end of the loan term, the untouched principal is dealt with, either by paying it off in full or making another arrangement like taking out another loan or working out a more traditional repayment plan.
Lowers Your Monthly Payments: Traditional loan payments are applied toward both interest and payments towards the principal of the loan. Interest only loans have lower monthly payments over the loan term because they don’t include regular payments towards the principal. This allows you to redirect revenues back into growing your business by freeing up your cash flow. You can minimize your overhead costs and still obtain necessary financing. Allow You to Borrow More Money: Because you’re only paying the interest at first, it’s possible to borrow larger amounts of capital and still be able to afford the monthly payments. This is especially useful for capital-intensive investments like real estate and/or new equipment that your restaurant will need to be successful. Helps to Plan for Fluctuating Revenue: The restaurant industry is notorious for busy and slow seasons, and inconsistent revenue streams can be a nightmare for restaurant owners with significant overhead costs. With an interest only loan, you have a lower monthly payment, and as your revenue ebbs and flows throughout the year you can start to make extra payments towards the loan during your busy seasons and get by with lower payments during slower seasons.
Interest only loans are not without their risks. Small business owners should be aware of all the associated risks before going through with this financing option. Going Underwater: Many purchases made by restaurants, especially for new equipment, are vulnerable to depreciation. By leaving the principal untouched, you risk settling the loan at a higher value than the current value of what you purchased. Prepayment Penalties: If you’re trying to chip away at the principal while taking advantage of a lower monthly payment, you may be out of luck. Some interest only loans include prepayment penalties, fees charged when borrowers try to settle their loan before the end of the loan term. Make sure to check for prepayment penalties in your loan’s terms before adopting a strategy for repayment. Planning for The Principal Can Be A Tall Ask: At the end of the interest payment term, you’ll have to deal with paying off the principal. This can be risky. If your revenues haven’t grown to the point at which you can afford to pay off the principal or afford traditional monthly payments and haven’t made any necessary arrangements, you’re in trouble. This can be especially hard with the fluctuating business cycle of a restaurant. Before committing to an interest only loan, make sure that you have a plan in place to deal with the principal.
Most flexible financial institutions offer interest only business loans to restaurants with good credit and strong potential cash-flow. Because interest only loans can be seen as a bit riskier for a lender, sometimes the requirements for personal credit scores, down payments, and other loan details are a bit more stringent than that for a traditional loan. Additionally, financial technology start-ups are known to offer innovative financing solutions which can include interest only options. Make sure to shop around, strategize, and compare plans to determine which interest only product works best for your business.
Interest only loans aren’t always the best option. If they don’t work for your situation, there are plenty of other more traditional options out there to help your business thrive. Small Business Administration (SBA) Loans: SBA loans are a great option for long-term financing. Backed by the US government, these loans offer low interest rates, low down payments, and long repayment terms. Lenders feel more comfortable lending through the SBA loan guarantee programs, and these loans can be used for a variety of business need. Equipment Loans: Financing the purchase of restaurant equipment can be done efficiently through equipment financing options. Often these loans will use the equipment purchased as collateral, which leaves other assets free as you pay back the loan. Business Line of Credit (LOC): A LOC can be used by a business owner to fund various business expenses flexibly. These can be helpful during short-term cash flow gaps during slower seasons. LOCs are usually used for larger spending that will take time to pay back.
