Longer amortization versus a lower interest rate

A longer amortization period can lower the monthly payment even when its interest rate is higher. That does not make it cheaper. Compare the cash preserved during the hold with the additional principal still owed at the planned payoff date.

The following two hypothetical offers fund the same $4 million, have the same seven-year maturity, and differ only in rate and amortization. No interest-only period, fees, reserves, or prepayment charge is included. Those items must be added before using actual offers for a decision.

Normalize the schedules before ranking them

Proposal L charges 7.25% and calculates monthly payments over 30 years. Proposal R charges 6.50% and calculates payments over 20 years. Both use the annual rate divided by 12, payments at month-end, and no irregular first period.

R requires approximately $2,535.87 more cash every month, or $30,430.49 annually, despite its lower rate. L’s longer repayment schedule offsets its higher interest charge enough to reduce the current payment.

The formulas use payment = P × i ÷ [1 − (1+i)^−n], with 360 payments for L and 240 for R. A real commercial loan can use different day-count or payment conventions. Freddie Mac’s fixed-rate product summary, for example, separately identifies amortization and calculation conventions. That program reference does not supply the invented terms here.

Compare three payoff dates on the same basis

Use month 24, month 60, and the contractual month-84 maturity as possible decision dates. The earlier payoffs are assumed permitted without charge solely to isolate amortization. Balances are calculated after the scheduled payment for each listed month.

R has the lower interest expense at every listed date. It also has the smaller balance because its larger payments retire principal faster. The additional cash payment is not all additional financing expense.

At month 60, L has preserved approximately $152,152 of cumulative payment cash relative to R. However, L still owes approximately $351,586 more principal. If the saved cash is retained without earnings and applied to payoff, the remaining disadvantage is approximately $199,434—the difference in cumulative interest.

This identity is a useful error check: additional ending debt minus cumulative payment savings equals additional interest when the initial principal and other costs are the same. A comparison that counts payment savings but ignores ending debt will incorrectly favor the higher-rate loan.

Test the current payment against an actual cash constraint

Assume the property produces $400,000 annually before financing and the owner wants at least $60,000 annually available afterward for additional liquidity. No other property cash uses remain outside that figure for this illustration.

L leaves approximately $72,555, meeting the owner’s target by $12,555. R leaves approximately $42,125, missing it by $17,875. The lower-rate proposal therefore requires another funding response even though it has better cumulative interest and balance outcomes.

That response could be a lower loan amount, a larger owner contribution, revised spending, or another approved loan structure. It should not be hidden by describing R’s payment as a lower “cost of debt.” The owner pays the full scheduled amount, including principal.

To meet the $60,000 annual residual target, scheduled debt service cannot exceed $340,000. At R’s assumed 6.50% rate and 20-year amortization, that supports approximately $3.800 million of principal, about $200,000 below the requested $4 million. The exact amount should be calculated using the unrounded payment factor and reconciled with the other loan constraints.

Connect the balance difference to the exit funding

At month 60, assume a new lender supplies $3.5 million and refinance costs are $100,000. L needs approximately $375,151 of owner funding. R needs approximately $23,565. These are refinance funding requirements, not additional interest expense.

If L retained its full $152,152 payment savings, it still needs approximately $222,999 beyond that reserve. If the owner used the savings to maintain the annual liquidity objective or pay other obligations, do not count the same dollars again as a refinance reserve.

The comparison exposes two different constraints: R uses more cash each month; L leaves more principal to finance at exit. Their relative importance depends on the actual property cash pattern and the owner’s available capital. A strong exit value does not solve a near-term payment shortfall, and low monthly payments do not establish sufficient refinancing proceeds.

Preserve the assumptions that can reverse the choice

Add actual initial fees, prepayment terms, rate resets, required reserves, and the owners’ use of retained cash. If the payoff occurs between scheduled payment dates, include accrued interest under the real convention. If the lower-rate offer also has a shorter maturity, it is no longer the isolated comparison modeled here.

Report payment, cumulative interest, ending balance, and funding needed at the intended exit in separate rows. The monthly-payment result answers whether the owner can carry the loan. The interest-and-payoff result answers what that flexibility costs over the hold. Both are necessary before accepting a longer amortization in exchange for a higher rate.