interestonly

Interest-only, or IO, refers to a financing arrangement in which the borrower pays only the interest due on the outstanding principal for a defined initial period. During this phase, the principal balance remains unchanged. After the interest-only period ends, the loan typically converts to a fully amortizing schedule, requires a balloon payment for the remaining principal, or must be refinanced.

Common applications include residential mortgages, commercial real estate loans, and certain structured notes or securities. In a mortgage, an interest-only period may last several years, after which payments include both interest and principal, or a large balloon payment is due. In other arrangements, the loan is extended through refinancing to reestablish an amortizing payment stream.

Advantages include lower initial payments and improved short-term cash flow for borrowers with fluctuating income, capital needs, or time-limited tax planning. IO structures can also enable faster acquisition of assets when immediate equity is not essential.

Risks include absence of principal reduction during the IO period, higher total interest over the life of the loan, and potential payment shock when the period ends or rates reset. The loan balance can grow if the structure allows unpaid interest or if refinancing terms are unfavorable, increasing default risk. These products typically require careful exit strategies and risk assessment.

Regulation and market usage vary by jurisdiction. After the financial crisis, lenders tightened underwriting for IO products and increased disclosures. Prospective borrowers should compare total costs, consider the timing of payments, and ensure alignment with long-term financial plans.