Interest-Only Loan

Because none of the payments go towards the principal, monthly payments on an interest-only loan are lower than on a repayment loan of the same size. However, the full amount borrowed is still owed at the end.

For example, on a 200,000 mortgage at 5%, interest-only payments would be about 833 a month. A repayment mortgage over 25 years at the same rate would cost about 1,169 a month, but the balance would be paid off by the end. With the interest-only loan, 200,000 would still be owed after 25 years.

Interest-only mortgages are often used by property investors who rent out properties, since they keep monthly costs low and plan to repay the loan by selling the property. Some homeowners use them with a separate plan, such as investments or a pension lump sum, to repay the loan at the end.

The main risk is that the borrower's repayment plan falls short, for example if investments perform poorly or property prices fall. Many lenders now require evidence of a credible repayment strategy before offering interest-only mortgages.