When to Consider an Interest-Only Loan
You may not hear as much about interest-only loans these days, and many lenders don’t offer them, but they are available through some lenders. If you are curious about this type of loan, it is important to understand how it works.
What Is an Interest-Only Loan?
An interest-only loan allows you to pay back only the interest on your loan for a set length of time, usually 5, 7 or 10 years. At the end of that period, the amount of principal owed is re-amortized over the remainder of the loan term and payments are adjusted accordingly. You may make principal payments during the interest-only period if you choose.
For instance, if you have a $300,000 loan and you reduced the principal by $20,000 during the first 10 years, the $280,000 will be re-amortized for the next 20 years. This will result in an increase in your payments. However, any time you make a payment on the principal, your interest payments will be reduced immediately.
Who Benefits from an Interest-Only Loan?
An interest-only loan is not as popular as it once was, especially after the housing crisis resulted in many people owing more on their homes than they were worth. Nevertheless, there are times when people may find interest-only loans appealing:
- Borrowers with non-traditional income
Buyers who rely on commission or bonuses may want to have a lower monthly payment and then pay on the principal when they receive their additional income. People who own businesses with fluctuating revenue may also prefer this type of loan, so they can pay the principal in a large sum without worrying about higher payments each month.
- Borrowers with expected income increases
Recent college graduates and other borrowers who expect a dramatic increase in income may want to have a lower monthly payment for a period of time, expecting their income to rise and afford the re-amortized payment at the end of the interest only period. If they know they will be able to handle a larger payment in the future, an interest-only loan could be a viable option.