Interest-only loan payments are fixed for a
set period of time during which the borrower pays
only the interest portion of the regular monthly
payment. There is no contribution towards the
principal during this period. Once the fixed
interest period is over, the loan reverts back to
the original terms. Now, the monthly payments are
adjusted so that the loan amortizes over the
remaining mortgage period. For instance, if the
mortgage were for a period of 30 years, and the
interest-only period were 5 years, the payments at
the end of 5 years would be adjusted so that the
loan amortizes in 25 years.
In the United States, a five or ten year interest-only period is
typical. After this time, the principal balance is
amortized for the remaining term. In other words, if
a borrower had a thirty year mortgage and the first
ten years were interest only, at the end of the
first ten years, the principal balance would be
amortized for the remaining period or twenty years.
The practical result is that the early repayments
(in the interest-only period) are substantially
lower than the later repayments. This enables a
borrower who expects to increase their salary
substantially over the course of the loan to borrow
more than they would have otherwise been able to
afford. Interest only loans were popular in the
1920s. Due to the depression and lack of work for
the average person, there were many foreclosures
during the depression. |
