Published on 8 November 2016

What is an interest-only loan

Every loan has a declared rate of interest. The interest could be a fixed rate or floating. It could be a combination as well, fixed for a few years and then adjustable as per the prevailing lending rates in the market. All standard loans are re-paid over a period and every instalment has a bit of the principal which is the loan amount and a bit of interest. Most loans are designed in a way wherein more interest is paid in the first few months or years and towards the latter half of the term it is more of the principal amount being re-paid and less of interest.

An interest only loan is an unconventional option in which you don’t repay any amount of the principal loan. You only repay the interest. Only when your interest is re-paid do you start repaying the principal loan amount. This is mostly applicable in cases of properties. Interest only loans are not readily available for all kinds of purchases or spending purposes.

Pros and Cons of Interest Only Loan

The Pros

  • An Interest only loan is beneficial for those who are looking at lower monthly repayments. Since the principal amount is not being considered in the initial instalments, the interest is split evenly into a certain number of months don’t amount to as much as it would had the principal been taken into the calculations.
  • Those who want to claim tax deductions may do well with an interest only loan. (Be sure to consult with your accountant on this point). This helps investors as well as business owners. Interest only loans are often opted for by property investors and commercial property owners.
  • Interest only loans help property investors who don’t intend to hold onto an investment for too long. They can keep paying lower instalments, flip the property or get a buyer and sell the asset for a nice profit. A standard loan doesn’t appeal much in such cases.

The Cons

  • Interest only loans make no sense for homeowners because all one pays is the interest and the entire principal amount is left to be re-paid. There is little room to save if one wants to repay the entire loan before the term ends.
  • It also doesn’t make sense to allow the lender to make all the profit and then to keep repaying the principal amount which can go awry if someone loses a job or incurs losses in business.
  • Not every lender offers interest only loans so there are fewer options available.

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