Kimberly Amadeo is an expert on U.S. and world economies and investing, with over 20 years of experience in economic analysis and business strategy. She is the President of the economic website World Money Watch. As a writer for The Balance, Kimberly provides insight on the state of the present-day economy, as well as past events that have had a lasting impact.
An interest-only loan is an adjustable-rate mortgage that allows the borrower to pay just the interest rate for the first few years. That’s often a low “teaser” rate.
That introductory period typically lasts between three to 10 years. ? ? After that, the loan converts to a conventional mortgage. The interest rate may increase and the monthly payment must also cover some of the principal. That increases the payment significantly. Some interest-only mortgages require the borrower to pay off the entire balance after the introductory period.
Advantages of Interest-Only Loans
The first advantage is that the monthly payments on an interest-only mortgage are initially lower than those of a conventional loan. That allows borrowers to afford a more expensive home.
That only works if the borrower plans to make the higher payments after the introductory period. For example, some increase their income before the intro period is over. Others plan to sell the home before the loan converts. The remaining borrowers refinance to a new interest-only loan, but that doesn’t work if interest rates have risen.
The second advantage is that a borrower can pay off an interest-only mortgage faster than a conventional loan. Extra payments go directly toward the principal in both loans. But, in an interest-only loan, the lower principal then generates a slightly lower payment each month.