| An interest-only loan is a loan in which for a set term | | | | much and which can be sold at the end of the loan to |
| the borrower pays only the interest on the principal | | | | repay the capital. For example, second homes, or |
| balance, with the principal balance unchanged. At the | | | | properties bought for letting to others. In the United |
| end of the interest-only term the borrower may enter | | | | Kingdom in the 1980s and 1990s a popular way to buy |
| an interest-only mortgage, pay the principal, or (with | | | | a house was to combine an interest-only loan with an |
| some lenders) convert the loan to a principal and | | | | endowment policy, the combination being known as an |
| interest payment (or amortized) loan at his/her option. | | | | endowment mortgage. Since the poor stock market |
| US interest only mortgages | | | | performance of the late 1990s, endowment mortgages |
| In the United States, a five or ten year interest-only | | | | have become unpopular. |
| period is typical. After this time, the principal balance is | | | | Canadian interest only mortgages |
| amortized for the remaining term.[1] In other words, if a | | | | Some interest-only mortgages in Canada allow the |
| borrower had a thirty-year mortgage and the first ten | | | | borrower to pay interest-only, principal and interest, or |
| years were interest only, at the end of the first ten | | | | even principal and interest plus 20% extra. An |
| years, the principal balance would be amortized for the | | | | interest-only mortgage in Canada can be combined |
| remaining period of twenty years. The practical result | | | | with corporate bonds in a Registered Retirement |
| is that the early repayments (in the interest-only period) | | | | Savings Plan (RRSP) where the plan holder receives a |
| are substantially lower than the later repayments. This | | | | tax deduction, tax deferral, and compound interest. |
| enables a borrower who expects to increase their | | | | From an investor's perspective |
| salary substantially over the course of the loan to | | | | Interest-only loans are sometimes generated articifially |
| borrow more than they would have otherwise been | | | | from structured securities, particularly CMOs. A pool of |
| able to afford, or investors to generate cashflow | | | | securities (typically mortgages) is created, and divided |
| when they might not otherwise be able to. During the | | | | into tranches. The cashflows that are received from |
| interest-only years of the mortgage, one is essentially | | | | the underlying debts are spread through the tranches |
| renting the house since none of the principal loan | | | | according to predefined rules, an Interest-only (IO) loan |
| decreases. The two great disadvantages are that in | | | | is one type of tranche that can be created, it is |
| many states one has to pay property tax and | | | | generally created in tandem with a principal only (PO) |
| purchase mandatory property insurance.[2]. On the | | | | tranche. These tranches will cater to two particular |
| other hand, the owner is still gathering appreciation, | | | | type of investors, depending on whether the investors |
| even if they aren't paying down equity against their | | | | are trying to increase their current yield (which they |
| loan, and there are many other tax advantages to | | | | can get from an IO), or trying to reduce their exposure |
| home ownership not available to renters. In cases of | | | | to prepayments of the loans (which they can get from |
| aggressive appreciation (e.g. "flipping" homes), a 100% | | | | a PO). |
| mortgage-to-value interest-only loan may also be able | | | | Many homeowners saw the values of their homes |
| to be converted to a conventional mortgage with a | | | | increase by as much as 4 times its price in some |
| more favorable mortgage-to-value loan, resulting in an | | | | markets in a 5 year span in the early 2000s. |
| overall lower payment. | | | | Interest-only loans helped homeowners afford more |
| UK interest only mortgages | | | | home and earn more appreciation during this time |
| Interest-only loans are popular ways of borrowing | | | | period |
| money to buy an asset that is unlikely to depreciate | | | | |