Interest-Only Loan
A loan where payments cover only interest for an initial period, after which principal repayment begins.
What is Interest-Only Loan?
An interest-only loan is a financing arrangement in which the borrower pays only the interest portion of the loan for a defined initial period—typically 5 to 10 years—without making any principal payments. During the interest-only phase, the outstanding balance remains unchanged and monthly payments are lower than on a fully amortizing loan. Once the interest-only period ends, the loan either converts to a fully amortizing schedule (causing a significant jump in monthly payments) or requires the balance to be paid off in a balloon payment. Interest-only loans are used in mortgages, HELOCs, and some commercial loans. They are particularly attractive to investors who expect to sell or refinance before the repayment phase begins, but carry higher long-term risk if property values decline or refinancing becomes unavailable.
Example
An investor takes a $500,000 interest-only mortgage at 7% for a 10-year term. During years 1–10, monthly payments are $2,917 (interest only). At year 10, the loan converts to a 20-year amortizing schedule, and monthly payments jump to approximately $3,876 — a 33% increase as principal repayment begins.
Source: Consumer Financial Protection Bureau — Interest-Only Loans