What type of loan allows the borrower to pay only the interest for a certain period of time?

An interest-only loan is structured to allow the borrower to pay only the interest on the loan for a specified period, which typically lasts from 5 to 10 years. During this time, the borrower is not paying down the principal balance, meaning their monthly payments are lower compared to traditional loans where payments include both principal and interest. This can provide financial flexibility, particularly for borrowers who may expect an increase in income or plans to sell the property before the end of the interest-only period. After this period, payments typically increase significantly, as the borrower will then start to pay back the principal along with interest based on the remaining balance.

Other loan types, such as amortized loans or fixed-rate loans, involve payments that contribute to both interest and principal from the outset, leading to a gradual decrease in the loan balance over time. Adjustable-rate loans may also have varying interest payments, but they typically do not allow for an interest-only payment structure unless explicitly designed that way. Therefore, the defining characteristic of an interest-only loan is its provision for borrowers to focus solely on interest payments for a designated time frame.