Interest only loans are (as you probably figured) interest based. With this kind of loan, a borrower only pays the interest due on the principal balance. In most cases, the principal balance does not change over the set term. After the interest only term expires the borrower typically has an option for one of the following:
- The borrower can covert the existing loan to an amortized loan wherein he makes regular payments on the principal and the interest.
- The borrower can also enter what is known as interest only mortgage, wherein he can make the payment on the principal amount.
The interest only period varies from one country to another, but in the United States the interest only period typically is in place for 3 – 5 years. This essentially means that if a borrower has to pay a loan over a period of thirty years, he can only go for the interest-only option for the first five years or first ten years. This is usually dependant on the choice he/she makes and the lending organization they use.
At some point the interest only term ends and the amortization of the principal balance takes place for the remaining years. The main advantage of the interest only loan is that the initial payments are much lower than the payment that a person makes later on. This enables borrowers to plan accordingly and they can borrow more amount of money than they can afford. This is done by taking into consideration the hope that their salaries might just see a substantial increase over the term of the loan.