Learn how interest-only loans work, their benefits for certain borrowers, and the critical considerations to keep in mind.
Interest-only loans are a type of non-traditional financing where, for a set period at the beginning of the loan term, the borrower pays only the interest on the principal balance, with payments towards the principal delayed until a later date. After the interest-only period ends, the borrower begins making payments on both the principal and interest.
This loan structure can be beneficial for borrowers with irregular income streams or those expecting a significant income increase in the future. It offers lower initial payments, providing financial flexibility. However, it's crucial to plan for the higher payments once the interest-only period concludes.
Interest-only loans carry risks, primarily because the borrower does not build equity during the interest-only period. Additionally, if property values decline, borrowers might find themselves owing more than their home is worth. Prospective borrowers should carefully consider their ability to afford the eventual higher payments and the potential for negative equity before choosing this financing option.
