Interest-Only Loan

With an interest-only loan you pay only the interest on your loan each month and pay nothing toward the reduction of the principal of your loan. Under this kind of arrangement at the end of your loan period you will still owe the full amount of your original loan which is due and payable in one lump sum.

Why would anyone want an interest-only loan? Primarily, people chose this type of mortgage because the accompanying monthly payments are less than they would be with a conventional fully-amortized loan. With a fully amortized loan your monthly payment includes a reduction in your principal which, at the conclusion of the loan period, the whole principal has been paid leaving a zero balance.

Since the monthly payments on a principal-only loan are smaller than the monthly payments on a fully-amortized loan, many people who could not qualify for the fully-amortized loan can qualify for the interest-only loan.

Typically an interest-only loan ends after five to seven years. At the end of the loan the loan is either paid off with funds the borrower has saved, or the property is sold to pay off the loan, or the loan may be refinanced at the then-current interest rates.

This type of loan works well for people who plan to live in a home for only a few years and then plan to sell. It can also work well in areas of the country where homes have appreciated in value consistently each year. Before accepting an interest-only loan it is advisable that you have a very specific plan for paying off the loan at the due date.