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An interest-only loan is a loan in which for a set term the borrower pays only the interest on the capital; the capital remains owing. At the end of the term the borrower repays the capital, or (with some lenders) converts the loan to a repayment loan.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, but ended up leading to a large number of foreclosures during the depression.
Interest-only loans are popular ways of borrowing money to buy an asset that is unlikely to depreciate much and which can be sold at the end of the loan to repay the capital. For example, second homes, or properties bought for letting to others. In the United Kingdom in the 1980s and 1990s a popular way to buy a house was to combine an interest-only loan with an investment in the stock market, the combination being known as an endowment mortgage. The stock market crash of the late 1990s showed this to be a gamble.
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