An interest-only period allows you to pay only the interest on the loan for a set number of years typically 5 to 10. Your monthly payment is lower during this period.
However you build no equity during the interest-only period. After it ends your payments increase significantly because you must pay both principal and interest over the remaining term.
Interest-only loans can be useful in specific situations but carry risks that borrowers need to understand.
How It Works
During the interest-only period your monthly payment covers only the interest due. The principal balance does not decrease. After the period ends the loan converts to fully amortizing meaning you pay principal and interest.
Payment Comparison
Example: 00K at 6.5%. Interest-only payment: ,625/month. Fully amortizing payment: ,896/month. After the interest-only period the payment jumps to the fully amortizing amount for the remaining years.
Who Uses It
Interest-only loans are used by real estate investors who plan to sell before the period ends borrowers with variable income who expect higher earnings later and those who prioritize cash flow over equity building.
Risks
The main risk is payment shock when the interest-only period ends. Your payment could increase by 30-50%. If property values drop you could owe more than the home is worth with no equity built.
Conversion Shock
Conversion shock happens when the interest-only period ends. Your payment increases significantly and you have less time to pay off the remaining balance. Some borrowers struggle to afford the higher payment.
When It Makes Sense
Interest-only loans make sense when: you have a short time horizon (3-5 years), you expect significant income growth, you are an investor with a clear exit strategy, or you are using the cash flow for higher-return investments.