Types of Loans

Financing for a property may be required for acquisition, major replacements, improvements, renovations, and rehabilitations. Thus, one responsibility of a real estate manager may be to compare mortgage loan options in order to select the most advantageous loan structure from available financing alternatives. It is important to first understand the various types of loans that can be obtained in the marketplace today.

Takeout
A takeout loan is permanent financing that is funded at the completion of construction, with the funds being used to pay off (take out) the construction lender.

Interest Only
An interest only loan (also referred to as a straight-term, standing, or demand loan) is a type of mortgage in which the borrower makes only interest payments until the maturity date. Then, the entire principal must be repaid in a single payment (refer to balloon loan below).

Fully Amortized
A fully amortized loan is characterized by periodic payments that include a portion applied to interest and a portion applied to principal. In the early years of the mortgage, a greater portion of the payment is applied to the interest. As the loan matures, a greater portion of the payment is applied to the principal, and the entire debt obligation is extinguished at the end of the loan term. Over the course of a fully amortized loan, the borrower builds equity in the property, and the lender gains additional cushioning against loss in the case of default of payment. There are two types of fully amortized loans, fixed rate and adjustable rate.

Balloon
A balloon, or partially amortized loan, has uniform periodic payments that include amounts for interest and principal, but the periodic principal payments do not fully amortize the mortgage because the term of the loan is shorter than the full amortization period. Thus, a substantial single payment, called a balloon payment, is due at the end of the loan term. This balloon payment is typically refinanced at a newly negotiated interest rate or is paid from the proceeds of a sale of the property. 
           
The advantage of a balloon loan to the borrower is that the periodic payments are lower than they would be for a fully amortizing loan because the lender can offer a balloon loan at a lower rate of interest since the loan term is shorter. The advantage to the lender is that the fixed rate of interest is not committed for long periods. The lender will receive the balance of the loan back earlier and will be able to make those funds available for future lending.

Rollover
A rollover loan is a long-term loan that sets a fixed interest rate for a certain number of years. At the end of that time, the loan must be rolled over at the prevailing interest rate. (The loan, however, can be paid off to avoid rolling it over, if that is a better business decision.)

Floor-Ceiling
A floor-ceiling loan sets a minimum amount to be loaned (the floor) and a maximum amount (the ceiling). They are also called earn-outs. Floor-ceiling loans are used when buildings are being rented and occupancy is uncertain. The lender commits to the minimum amount, with the maximum amount dependent on the property’s progress. If the required occupancy level is not reached, the ceiling amount is not lent. The real estate manager’s performance is key to the success of this type of borrowing. Because so much is at stake, owners carefully and frequently monitor property managers to see if they are meeting targets.

Gap
Gap loans are frequently short-term loans used to cover a financial gap such as the amount between the floor and ceiling in a floor-ceiling loan. Typically, interest rates are higher with gap loans.

Wraparound
A wraparound loan is a junior mortgage loan that permits a second lender to finance a borrower by lending an amount over and above the existing first mortgage balance that is not distributed or paid off. (If numerous senior mortgages already exist, a wraparound loan could legally be a third, fourth, or fifth lien against the property.)

The important feature of a wraparound loan is that the face amount of the loan is equal to the balance of the existing loan(s) plus the amount of new financing. The wraparound loan usually calls for a higher interest rate than the existing loan, and that higher interest rate covers the entire amount of the loan, even though the wraparound lender provides only a relatively small amount of new money. The wraparound loan is used when the cost (interest rate) of traditional secondary financing would be too high to meet the borrower’s investment objectives.

With this loan, the borrower pays the wraparound lender debt service on the entire amount of the loan. In turn, the wraparound lender pays the debt service due to the first mortgage holder. This arrangement allows the new lender of the wraparound to protect the second mortgage lien position by ensuring that the first mortgage is properly paid.

• The advantage to the borrower is an overall lower interest rate on the entire amount of the loan than the current interest rate because the lower-rate first mortgage remains in effect.
• The advantage to a wraparound lender is a higher-than-current interest rate because of the difference between the wraparound rate and the first mortgage rate.

Secondary Financing
Secondary or junior financing refers to second, third, and other mortgages. The first mortgage has priority—it is the first (or senior) lien against the property and has the first claim. Any other mortgage or financing is junior to it. Secondary financing is a way of using funds for improvements to a property without making changes to the first mortgage, which may have been made at favorable terms. The primary mortgage-holder may need to approve this type of financing. It is a shorter-term loan that has a higher-risk rate and higher interest rate.

Interim Financing
Interim financing is a temporary or short-term loan secured by a mortgage and generally paid off from the proceeds of permanent financing. A construction loan, a short-term loan that remains outstanding during the time needed to complete construction, is a common form of interim financing. Construction loans are often replaced by permanent financing, longer-term loans that are usually amortized over 25 to 30 years. Bridge loans may be used for financing between two events; the most common situation being between the construction loan and the completion of permanent financing.

Equity Investments
Some loans allow equity participation:An equity participation loan allows the lender to share directly in the cash flow.

• A convertible mortgage is a conventional mortgage that gives the lender an option to acquire a portion of the mortgaged property.
• Joint ventures between lenders and investors are arrangements that allow equity participation for lenders and long-term financing for investors.
• In a sale-leaseback, the investors actually sell the property and lease it back for a specified number of years at a predetermined rent.