What is a key risk associated with interest-only payment loans?

The key risk associated with interest-only payment loans is the considerable amount of principal risk. With these types of loans, borrowers only pay the interest for a specified period, meaning that the principal balance does not decrease during that time. This structure can lead to a significant risk when the loan term ends, as the borrower may have to repay the entire principal amount all at once or face a substantial increase in monthly payments if the loan converts to a principal-and-interest payment structure.

This situation can be particularly concerning if the property value declines or if interest rates rise, as the borrower could find themselves owing more than the home is worth, or burdened by higher payments they cannot afford. Therefore, understanding the implications of interest-only loans is crucial for both borrowers and lenders, as it highlights the potential financial risk involved.