Interest-only period

Understanding Interest-Only Period

An ‘Interest-Only Period’ is a defined time period during the loan term where the borrower is only obligated to make interest payments on the loan. This period is typically at the beginning of the loan term and can last for several years. During this time, the borrower will not pay down any of the principal balance, only the interest. This can result in lower monthly payments for the borrower during the interest-only period, but higher payments later when the loan switches to paying both principal and interest.

Interest-only periods are commonly found in adjustable-rate mortgages, balloon mortgages, and certain types of commercial loans. Borrowers may choose this type of loan structure if they anticipate a significant increase in income in the future, if they plan to sell the property before the interest-only period ends, or if they want the flexibility of lower payments during the initial years of the loan. However, this can also lead to higher financial risks, as the loan balance does not decrease during the interest-only period, and payments will increase once principal payments begin.

It’s important for homeowners and borrowers to fully understand the implications and potential risks of an interest-only period before entering into such a loan agreement. Financial advice should be sought to ensure it aligns with the borrower’s financial capability and goals.