Interest only

An interest-only loan is a financial arrangement where, for an agreed-upon term, typically ranging from one to five years or during a construction period, the borrower is only required to make payments covering the accrued interest on the loan. The principal amount is not reduced during this interest-only period. Subsequently, once this period expires, the borrower typically transitions to repaying both principal and interest over the remaining term of the loan.

Five Key Points: 

Interest-Only Period: During the specified interest-only term, the borrower makes monthly payments solely covering the interest portion of the loan. This means that the loan principal remains unchanged during this period.

Common Use: Interest-only loans are often used in real estate financing, especially for mortgages. They can be advantageous for borrowers who wish to reduce initial monthly payments or who expect a significant increase in income or intend to sell the property before the end of the interest-only term.

Transition to Principal and Interest: At the end of the interest-only period, the loan structure typically shifts, and the borrower starts repaying both the principal and the interest. This transition may result in higher monthly payments.

Risk and Considerations: Borrowers should be aware that interest-only loans carry some financial risk. During the interest-only period, the loan balance remains the same, and the borrower does not build equity in the property. If the property's value does not appreciate as expected, or if the borrower cannot afford the higher payments after the interest-only period ends, it can lead to financial challenges.

Flexibility and Planning: Interest-only loans can provide financial flexibility and are often used by investors and individuals with specific financial strategies. However, they require careful planning and consideration of long-term financial goals and the ability to handle the eventual transition to principal and interest payments.