Dutch, Non-Dutch, or No Monthly Payments: Which option is best?

Dutch, Non-Dutch, or No Monthly Payments: Which is the best repayment option for my project?

Introduction:

In the world of investment real estate, there are many different ways to finance a fix-n-flip or fix-to-rent project. Those who choose to utilize the benefits of private money know that there are multiple ways to repay their interest only loans. In this article, we will discuss the three most popular repayment methods, how they are different, and in which situations one may be better than another.

Part 1 - Dutch Repayment Schedule:

This is the most common method of repayment. In a Dutch repayment plan, the borrower pays a monthly interest only payment based on the loan amount that they agreed to borrow. For example, if you have a $100,000 loan and your interest rate is 10%, your Dutch repayment schedule will be based on ($100,000 x 10%) / 12 = $833.33 per month.

The key benefit to a Dutch repayment schedule is that they are often easier to find, the approval requirements are lenient, they tend to close quickly, and the calculation is very straight forward easy to keep up with. Your payment is the same every month and the lender will collect more interest in this format because the borrower is paying interest on the entire loan amount from day one.

The key downside to this repayment schedule is that the borrower is paying interest every month, based on the entire loan amount (including the amount being held in reserve for rehab draws), even if no draws have been taken yet.

Part 2 - Non-Dutch Repayment Schedule:

The key difference between Dutch and Non-Dutch is that with a non-Dutch repayment schedule, the borrower pays monthly interest based on the portion of the loan that has been drawn. If we use our example from earlier of a $100,000 loan, where $70,000 goes toward the purchase price and $30,000 is being held in reserve for renovations, the first month’s payment would be based on the $70,000 that went toward the purchase. The interest on the remaining $30,000 would be assessed as the borrower uses holdback funds from the rehab budget. In this example, the first month’s payment on a non-Dutch repayment schedule would be ($70,000 x 10%) / 12 = $583.33. The monthly payment would increase each month, based on the amount that was drawn for renovations. The maximum monthly payment (after all rehab funds have been drawn) would be $833.33.

The benefit to using a non-Dutch repayment schedule is that the borrower does not have to begin repayments at $833.33 right away and as a result, can save money on interest payments over the loan term.

The downside to this repayment schedule is that the lender makes less interest. Some lenders do not offer this option for that reason.

Part 3 - No Monthly Payment Program:

The third option we will cover in this article is the No Monthly Payment Program. This option is different from the first two because (as the name suggests) the borrower will not make monthly interest payments at all. Instead, interest is accrued into the loan balance and paid at maturity (when the borrower either sells the property or refinances the loan). This option eliminates the need to make interest payments each month.

The obvious benefit of this option is the increased cash flow. If you do not have to make a payment each month, that alleviates the consistent outflow of cash and enables the borrower to focus on the renovations and completing the project as efficiently as possible. Another benefit of this option is that there is no additional liquidity requirement at closing. Normally, borrowers are required to show liquidity at closing to ensure they can service the debt, but since the debt service is coming from the escrow holdback for monthly payments, the borrower only needs to have enough cash to close. This option is ideal for converting to an income property because the (when the renovations are complete, and the property is stabilized) the borrower can begin receiving income from the property before regular mortgage payments are due. This further ensures that the borrower will be able to enjoy positive cash flow on the property sooner. Aside from the traditional long-term rental, the borrower could opt for a short-term rental income strategy instead, in order to generate higher cash flow in a peak period and then sell the property before the 12-month loan term expires. This option also serves as a benefit to the lender (and potentially the broker) because origination is based on the total loan amount. The commission on the transaction is increased by including the escrow account specifically designated for covering the monthly payments into the total loan amount.

The key drawback to this strategy is (much like the Dutch repayment schedule) that the interest will be calculated based on the total loan amount. Even though the borrower is not paying interest payments each month, interest is still accruing based on the total loan amount from day one (including the portion that is held back for renovations).

Part 4 – Examples: Let’s look at two examples to help illustrate the point.

Example 1: $250,000 towards purchase, $50,000 towards rehab.

- Dutch Repayment Schedule: ($300,000 x 10%) / 12 = $2,500/mo. The total interest paid would be $30,000 if the loan is outstanding for 12 months. The origination would be based on a $300,000 loan amount.

     o After 12 months, the payoff plus interest paid would be $330,000.

- Non-Dutch Repayment Schedule: ($250,000 x 10) / 12 = $2,083.33in the 1st month. If the project is complete in 10 months and sold in 12 months, the example repayment schedule would be at $5,000 draw increments. The monthly payments would increase incrementally until month 11 when it would reach the max of $2,500/mo. The origination would be based on a $300,000 loan amount.

     o After 12 months, the payoff plus interest paid would be $327,708.33.

- No Monthly Payment Program: ($250,000 for purchase, $50,000 for rehab, and $30,000 for monthly payment escrow). The origination would be based on a $330,000 loan amount.

     o After 12 months, the payoff plus interest accrued would be $330,000

In Example 1, the borrower may decide that the increased cash flow with No Monthly Payments and the ability to start receiving income (perhaps around $2,500 to $3,000/month) on the property without having to make mortgage payments could far out way the savings of $2,291.67 over the non-Dutch schedule. If the property generates income for even 1 month, that only further makes the case for the No Monthly Payment option, in this example.

Example 2: $50,000 towards purchase, $250,000 towards construction.

- Dutch Repayment Schedule: ($300,000 x 10%) / 12 = $2,500/mo. The total interest paid would be $30,000. The origination would be based on a $300,000 loan amount.
     o After 12 months, the payoff plus interest paid would be $330,000.

- Non-Dutch Repayment Schedule: ($50,000 x 10%) / 12 = $416.67 in the first month. We will assume 10 construction draws at a rate of $25,000 per draw. The monthly payments would increase incrementally until month 11 when it would reach the max of $2,500/mo. Your total interest paid would be $18,541.67.

     o After 12 months, the payoff plus interest paid would be $318,541.67.

- No Monthly Payment Program: ($50,000 for purchase, $150,000 for rehab, and $30,000 for monthly payment escrow). The origination would be based on a $330,000 loan amount.

     o After 12 months, the payoff with interest accrued would be $330,000

In Example 2, there is a significant savings ($11,458.33) with the non-Dutch option over both the No Monthly Payment and the Dutch repayment option. This is because the borrower is not paying interest on the $250,000 construction budget from day one.

Summary: Which option is best for my project?

There are many factors to consider when answering the question of which option is “best”. The answer largely depends on the type of investment strategy you will employ, your current liquidity situation, and the size of your renovation budget. Things like your available liquidity, your estimated time horizon for project completion, and your intent to turn the property into an income property (either short-term or long-term) could all impact your decision. Generally, a larger renovation budget tends to lean towards a non-Dutch repayment schedule. If you have a smaller renovation budget and you intend to utilize the BRRR method (or turn the property into an income property rather than selling it), the No Monthly Payment option tends to be a better solution because of the increased cash flow. A Ground Up Construction project, however, would be an ideal situation for a non-Dutch schedule. On the other hand, if you only have a $15,000 renovation budget and you plan to put tenants into the property in 3 months or less, a No Monthly Payment option would make more sense for maximizing monthly cash flow.

Look for lenders who provide multiple repayment options. The increased flexibility gives you more control and enables you to select which repayment option best fits your needs. We hope you found this article to be helpful and informative. If you like the content, be sure to let us know. Happy investing!

Nworie Capital