Difficulty: Medium

Average Score: 67%

If a borrower takes out an interest-only loan, when are they expected to pay the principal of the loan?

Rationale

Borrowers are expected to pay the principal as a balloon payment at the end of the loan term.

In an interest-only loan, the borrower pays only the interest during the loan term and must repay the principal in a lump sum, known as a balloon payment, at the end of the term. This structure allows for lower initial payments but requires careful planning for the eventual repayment of the principal.

A (in periodic monthly payments) YOUR ANSWER

Interest-only loans do not require periodic monthly payments of the principal; instead, borrowers only pay interest during the loan term. The principal is deferred until the end of the term, which distinguishes this type of loan from traditional amortizing loans that require both principal and interest payments throughout the term.

C (They aren't; interest over time will add up to more than the principal amount.) YOUR ANSWER

While it is true that interest accumulates over the life of the loan, borrowers are still obligated to pay back the principal amount, typically as a balloon payment at the end of the term. This choice misrepresents the borrower's responsibility to repay the principal, which remains unchanged regardless of interest accumulation.

D (only after the borrower refinances) YOUR ANSWER

Refinancing is an option that some borrowers may choose, but it is not a requirement for repaying the principal of an interest-only loan. The principal must be paid back at the end of the loan term, regardless of whether or not the borrower refinances; thus, this choice does not accurately represent the loan's repayment structure.

Conclusion

In summary, interest-only loans require borrowers to pay the principal as a balloon payment at the end of the loan term, rather than through periodic payments or refinancing. Understanding this repayment structure is crucial for borrowers to prepare financially for the eventual lump-sum payment, ensuring they avoid potential pitfalls associated with deferred principal repayment.

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