Which of the following best describes an interest-only loan?

Which of the following best describes an interest-only loan?

• A. Payments are made towards the principal and interest.
• B. Payments are made only towards the interest.
• C. Payments cover only the fees associated with the loan.
• D. Payments increase each year based on loan terms.

Answer: (B)

An interest-only loan is characterized by a payment structure where the borrower is only required to make payments that cover the interest for a specified period, typically the initial years of the loan. This means that during this time, the principal balance does not decrease, as no payments are applied towards reducing the loan's principal amount. This type of loan can be beneficial for borrowers who anticipate a higher income in the future, as it allows them to keep their initial monthly payments lower. However, it also requires careful planning, as once the interest-only period ends, the borrower will have to start paying both principal and interest, potentially resulting in significantly higher monthly payments. Considering the other options, they reflect standard mortgage payment structures where payments are typically made towards both the principal and interest, focus solely on fees, or increase regularly based on specific terms, which do not align with the fundamental nature of an interest-only loan.

An interest-only loan is characterized by a payment structure where the borrower is only required to make payments that cover the interest for a specified period, typically the initial years of the loan. This means that during this time, the principal balance does not decrease, as no payments are applied towards reducing the loan's principal amount.

This type of loan can be beneficial for borrowers who anticipate a higher income in the future, as it allows them to keep their initial monthly payments lower. However, it also requires careful planning, as once the interest-only period ends, the borrower will have to start paying both principal and interest, potentially resulting in significantly higher monthly payments.

Considering the other options, they reflect standard mortgage payment structures where payments are typically made towards both the principal and interest, focus solely on fees, or increase regularly based on specific terms, which do not align with the fundamental nature of an interest-only loan.