As previously discussed, all loans consist of two portions; principal and interest. However not all payments have to consist of both elements. An Interest Only (IO) loan will only make payments that service the interest. Repayments on these loans ONLY SERVICE THE INTEREST AND DO NOT PAY OFF ANY OF THE INITIAL AMOUNT BORROWED.

An IO loan is generally taken out for investment purposes. This is because the repayments will be less than those of a P&I loan for the same amount, as there is no 'principal' portion in the repayment, and the borrower is relying on the capital growth (increase in value) of the property (or shares, or investment) to result in an amount larger than the initial borrowed amount to gain a profit. An IO loan can usually be taken out for a period of 1 - 5 years, over a 25-year term. You should always be very careful when arranging an IO loan for a client, and make sure that the term allows the client enough flexibility to pay back the loan at a time convenient to them.

 For example, if a client takes a five-year IO out for a term of five years, they will have to pay the complete amount of the initial borrowings back at the end of five years. If they take a 5-year IO loan out over a 25-year term, it means that they've got a maximum of 25 years in which to pay back the principal. After the initial 5 years (or what ever period they had the loan as Interest Only) the loan will generally revert to the lender's standard variable rate product (explained later) or principal and interest on the same product, or they can renegotiate another IO term of up to five years. Interest only loans can usually be done with both fixed rate and variable rate products, depending on the lender (please see below for Fixed and Variable rates).