An interest-only loan is a type of loan where the borrower is allowed to only pay the interest on the total loan amount for a specific period of time. Ordinarily, when a borrower acquires a financial loan from a lender, they mutually agree upon a rate of interest that the borrower has to pay on the total amount of loan they obtain. Once they start paying the loan back, they have to make periodic payments to the lender that includes a part of the loan amount with added interest. These periodic payments are typically made on a monthly basis. Now, in an interest-only loan, the borrower can start by only paying the outstanding interest amount on the total loan for a fixed period of time.
Under the provisions of an interest-only loan, the monthly payments that the borrower is liable to make to the lending institution are considerably lower when the total loan balance is subtracted. However, it should be noted that this does not mean that the borrower is entirely exempted from paying back the remaining loan amount. It simply means that in the initial stages of repayment, the borrower can start by paying only the interest on the loan and thus have reduced liability for a fixed period of time.
When it comes to real estate, such interest-only loan arrangements are typically seen in home loans or mortgages. They are known as interest-only mortgages. Under such mortgages, the borrower pays only the interest amount on his mortgage for a certain period. Under this context, the borrower is liable to pay the remaining mortgage amount either in a lump sum amount at a fixed date or in subsequent monthly payments.
It should be noted that such interest-only home loans are typically structured in the form of adjustable-rate mortgages. By opting for interest-only mortgages, the loan borrowers can acquire plans with lower monthly payments. This is preferred by loan borrowers that seek lower periodic payments in comparison to other home loans with fixed mortgage payments. When a prospective home buyer approaches the option of interest-only home loans, it allows them to have a more beneficial cash flow for the initial years of the repayment period. It should be noted that the typical period permitted by lending institutions for borrowers to exclusively pay interest on their loans is 5-10 years. After this period of time concludes, the borrowers are automatically liable to start payments on the remaining principal amount.
As urbanisation is getting more rapid, there has been a significant increase in the need for house hunting. More people means more demand for houses. And since not everyone can afford to buy them in one shot, most prefer to raise loans for them. Now with so many options available out there for a borrower when looking to apply for a loan, it would be wise to first shop for your options. Out of the various loans available one of them is Interest only loans.
As the name suggests, interest-only loans are structured in such a way that the borrower only pays the interest for a certain period of time. It could either be for a fixed period after which it becomes fully amortised or for the entirety of the loan period. If it is interest-only for the entire tenure of the loan, the borrower has to pay the entire principal amount in a lump sum on a specified date or time. However, with most lenders, this option for interest-only loans is available only for certain borrowers who meet their qualifications for the loan.
Interest-only loans are a type of adjustable-rate mortgage. In most cases, the interest-only payment is available only for the introductory period, which depending on the lender may last for five to ten years. After which the borrower has to start paying both the interest and a part of the principle. And since it is a type of adjustable rate mortgage, the rate of interest also starts to change periodically.
Even though it allows the borrower to pay less money for a specific period of time, it may not be a suitable option for many. It is so because it requires a lump sum payment of the principal amount which some borrowers might not be able to arrange.
What is above mentioned as a drawback could turn out to be a perk for some other borrowers who have managed to save up through all this period by not paying the principal amount.
Just paying interest indicates that the borrower has not built any equity in the property for all these years. So even though they have the house, they have no ownership of the property.
Based on their financial planning, some borrowers may also choose to convert the loan and get it refinanced once the interest-only term expires.
