With an interest-only loan, the borrower’s regular payments include only interest, not the principal amount of the loan. A line of credit is a good example of an interest-only loan.
Because there are no principal payments, the monthly servicing requirements are low. They can also be paid back and then “redrawn” (meaning borrowed again) without penalty, making them highly flexible.
An interest-only loan is generally a floating-rate loan with a pre-set limit (maximum amount). Usually it is set at the prime rate plus a percentage of interest to reflect the lender’s risk––such as prime plus 1.5%. There is usually no term or amortization period. As long as payments are made regularly, these loans can operate indefinitely.
More about interest-only loans
Most interest-only loans are lines of credit. Less commonly, an interest-only loan may be a demand loan, repayable to the lender in full at any time. Such loans are generally made to give individuals the cash to buy into a business partnership, make a shareholder injection into the business, or to obtain short-term bridge capital to cover immediate costs.