Which type of loan allows a borrower to pay only the interest initially?

An interest-only loan is a type of mortgage that allows the borrower to pay only the interest on the loan for a specified period, typically five to ten years. During this initial period, the principal balance remains unchanged because no payments are being made towards it. This structure can result in lower monthly payments initially, which may be appealing to borrowers who anticipate higher income in the future or who plan to sell or refinance before the interest-only period ends.

After the interest-only period concludes, the borrower will then start receiving amortized payments that include both principal and interest, which can lead to significantly higher payments.

Understanding this structure helps clarify the appeal and potential risks associated with interest-only loans, particularly regarding the eventual increase in monthly payment obligations once the initial period ends. This knowledge is essential for a Mortgage Loan Officer when advising clients on their borrowing options.