Interest-only loan
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An interest-only loan is a loan in which for a set term the borrower pays only the interest on the capital; the capital remains owing. At the end of the term the borrower may renew the interest-only mortgage, repay the capital, or (with some lenders) convert the loan to a principal and interest payment loan at his option. It should be noted that some interest-only mortgages in Canada allow the borrower to pay interest-only, principal and interest, or even principal and interest plus 20% extra.
In the [[United States]], a five or ten year interest-only period is typical. After this time, the principal balance is amortized for the remaining term. In other words, if a borrower had a thirty year mortgage and the first ten years were interest only, at the end of the first ten years, the principal balance would be amortized for the remaining period or twenty years. The practical result is that the early repayments (in the interest-only period) are substantially lower than the later repayments. This enables a borrower who expects to increase their salary substantially over the course of the loan to borrow more than they would have otherwise been able to afford. Interest only loans were popular in the 1920s. Due to the economic downturn and lack of work for the average person, there were many foreclosures during the Great Depression of the 1930s.
Interest-only loans are popular ways of borrowing money to buy an asset that is unlikely to depreciate much and which can be sold at the end of the loan to repay the capital. For example, second homes, or properties bought for letting to others. In the United Kingdom in the 1980s and 1990s a popular way to buy a house was to combine an interest-only loan with an investment in the stock market, the combination being known as an endowment mortgage. The stock market crash of the late 1990s showed this to be a gamble. An interest-only mortgage in Canada can be combined with Corporate Bonds in a Registered Retirement Savings Plan (RRSP) where the plan holder receives a tax deduction, tax deferral, and compound interest.