The entire principal of an interest-only loan is the:
amount that has been repaid.
total number of payments made.
original loan amount.
total interest owed.
The correct answer and explanation is :
The correct answer is:
Original loan amount.
Explanation:
An interest-only loan is a type of loan where the borrower is required to pay only the interest on the loan for a specified period, typically the first few years. During this time, the principal amount (the original loan amount borrowed) remains unchanged because the borrower is not making any payments toward reducing it.
How Interest-Only Loans Work:
- Interest-Only Period:
- The borrower makes payments that cover only the interest.
- No portion of the payment goes toward reducing the principal balance.
- This period usually lasts between 5 to 10 years.
- After the Interest-Only Period:
- The borrower must start repaying the principal along with interest.
- Payments increase significantly since the loan must be repaid within the remaining term.
- Some loans may require a balloon payment (a large lump sum) at the end of the term.
Key Reasons the Correct Answer is “Original Loan Amount”:
- The principal of an interest-only loan refers to the original loan amount borrowed, not the amount repaid.
- The borrower does not pay down the principal during the interest-only period.
- The principal remains unchanged unless the borrower makes additional payments toward it.
This type of loan is often used by borrowers who expect their income to increase in the future, investors who want to keep payments low, or those who plan to sell the property before the principal payments start. However, it comes with risks, including potential payment shock once the interest-only period ends.