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Interest Only Loan Formula:
Where P decreases as extra payments are applied to principal
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An interest-only loan is a type of loan where the borrower pays only the interest for a certain period, with the principal amount remaining unchanged during this period. This results in lower initial payments compared to amortizing loans.
The calculator uses the interest-only formula:
Where:
When extra payments are made, they reduce the principal amount, which in turn reduces the subsequent interest payments.
Details: Making extra payments on an interest-only loan directly reduces the principal balance. This reduction lowers the interest portion of future payments, potentially shortening the loan term and reducing total interest paid over the life of the loan.
Tips: Enter the principal amount in dollars, annual interest rate as a percentage, and any additional monthly payment you plan to make. The calculator will show your initial payment and adjusted payment if extra payments are applied.
Q1: What are the advantages of interest-only loans?
A: They offer lower initial payments, which can be beneficial for borrowers with variable income or those expecting higher future earnings.
Q2: What happens after the interest-only period ends?
A: After the interest-only period, payments typically increase significantly as you begin paying both principal and interest.
Q3: Are there risks with interest-only loans?
A: Yes, the main risk is payment shock when the interest-only period ends and payments increase. There's also the risk of not building equity during the interest-only period.
Q4: How do extra payments affect an interest-only loan?
A: Extra payments reduce the principal balance, which decreases the interest portion of future payments and can shorten the loan term.
Q5: Should I consider an interest-only loan?
A: This depends on your financial situation, risk tolerance, and future income expectations. Consult with a financial advisor before making this decision.