Learn About Interest-Only Loans Where You Pay Interest First

It’s typical for lenders to apply your interest to your account every month. Your minimum payment will cover the monthly interest, as well as a reducing the total amount that you’ve borrowed. With an interest-only loan, where you pay interest first, your debt won’t decrease on its own.

What Are Interest-Only Loans?

Interest-only loans have a lower monthly repayment, as you're only repaying your interest. The interest rates will be higher than a standard loan. At the end of the term, you'll still owe the original balance of the loan.

Usually, you make an interest payment and take money off your loan balance monthly. With interest-only loans, you won’t pay down your loan balance until you are ready. Interest-only loans come with lower monthly payments.

Your minimum payment covers only the interest, so it’s a lot lower every month, but you’ll have to make a deliberate effort to eventually reduce what you owe.

Continue reading and learn how interest-only loans work and get the full pros and cons.

Looking for other information on Loans? This guide has info on 'What loans are available where you pay interest first? We have also writen extensively about:

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• - What loans are available that are easy to get approved for?

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How Interest-Only Loans Work

With an interest-only loan, you’ll only pay your interest every month. The total amount that you’ve borrowed won’t go down on its own. Your monthly payments will be lower, since you’re not clearing your debt as you go along.

An interest-only loan can help if you’re short on funds. If you don’t have much money for loan repayments, this option is usually cheaper. At some point, you’ll need to increase your payments and make an effort to clear your debt.

You can choose to make higher payments whenever you’re able to. This will start to reduce the balance of your loan. Interest-only loans can be beneficial for those with a fluctuating income, like freelancers or employees on zero-hours contracts.

With an interest-only loan, or a loan where you pay interest first, your loan can become much more manageable.

Pros of Loans Where You Pay Interest First

Loans, where you pay interest first, are better if your income tends to fluctuate. Perhaps you have a different income every month, or you’re a freelancer with ever-changing earnings. With an interest-only loan, your minimum payments will only cover loan interest, so they’re much lower every month.

You can choose to make higher payments only when you’re financially comfortable. Boosting your payment starts to clear your loan bit-by-bit. You can also choose to pay the minimum, setting aside your spare money every month and then clearing the loan in full when you’ve saved up enough.

An interest-only loan gives you more control over your monthly budget. In months when you don’t have much income, you’ll make a payment that just covers the interest. In months when you’ve got more money going spare you can start to bring down your debt level.

Cons of Loans Where You Pay Interest First

You’ll need to be self-motivated to clear your interest-only loan. You’re not actually clearing your debt, so even as you make payments each month you’re still in just as much debt as when you started.

Your debt doesn’t go away. By paying interest-only, you simply delay the inevitable. At some point, you’ll need to clear your debt, so if you can afford to start straight away this usually works in your favour.

Whilst lenders do their best to calculate the interest you’ll need to pay over a loan term, it’s important to remember that interest can still be added. Interest rate changes can still affect you, and leaving your loan just as high as when it started can mean that you’re always paying the maximum possible interest.

When to Use Interest-Only Loans

It can be tempting to use interest-only loans just to reduce your monthly payments. It’s important to remember that this won’t clear the debt, and you’ll still owe all that money back.

Interest-only loans are better used if your income seems to change every month, and you could pay extra every few months and start to clear your total loan balance. That way, when you reach the end of the original term, you won’t see your repayments shoot up considerably and potentially leave you in a difficult financial situation.

These loans might also suit you if you’re currently short on extra money, but know that you’ll soon have a higher income. Perhaps you know that you’ve got a windfall due, or you know that you’re moving to a job where you’ll be paid more.

If you use an interest-only loan, you can make much smaller repayments until you’re in a stronger position and can raise your payment amounts.

Loan Comparison

This is a comparison between a standard £3,000 personal loan, and a £3,000 interest-only loan, calculated at typical rates.

Numbers produced by Money Savings Advice

Applying for Interest-Only Loans

You’ll need to look specifically for loans where you pay interest first. These aren’t common but are typically used for larger expenses like mortgages. It’s fairly unusual to find a personal loan that’s provided in an interest-only format since this type of loan usually requires something that’s used as collateral.

Finding an interest-only personal loan may be more challenging, but isn’t absolutely impossible. You’ll still be subject to all of the usual credit checks and assessments.

You might need to provide some sort of security, in the form of collateral for the loan. You’re more likely to find interest-only loans if you search for secured loans. Lenders may agree to an interest-only loan if it’s backed by a vehicle or property.

Alternatively, use a bank overdraft as an interest-only loan. These work in the same way, giving you as long as you need to pay back what you owe.

A bank overdraft is just like an interest-only personal loan. If you borrow £500, your interest will be added every month. You can keep your overdraft at the same level whilst only paying off the monthly interest, then slowly reduce your overdraft until you’re back in positive figures.

As you start to clear your debt, your monthly interest will drop. You’ll need to pay less and less as a minimum, and if you keep your payments the same then you’ll begin to bring your overdraft down.

Alternatives to Loans Where You Pay Interest First

Being hard to come by, interest-only loans aren’t the best option for everyone. It’s much easier to get a bank overdraft if you hold a current account.

Often people look for interest-only loans because they don’t have much spare money every month. They need to keep their minimum payments as low as they possibly can. If that’s your situation, there are other ways to get the money you need.

Consider applying for a credit card, where you can make the minimum payments whilst maintaining your credit card balance. You can then also look to transfer the balance to other credit cards to freeze the interest if you start to struggle or you just want to be savvy.

Loans With Higher Chances of Approval

Interest-only loans represent a higher risk for lenders because they don’t know when you’ll pay the money back.

If you can afford to pay more every month, you’re more likely to be approved for other types of personal loan. Consider applying for a smaller loan, so that your monthly payment (even when it’s reducing your debt) is an amount that you can manage to keep paying. Often, it’s much easier to borrow less and clear your debt than to borrow more and only pay the interest.

Only borrow what you really need to borrow. It’s tempting to add a little extra for other things that you might want, but by keeping your loan as small as possible you’re making it easier to manage.

How Can Money Savings Advice Help You With Getting a Loan?

Here at Money Savings Advice, we have partnered with some of the UK’s leading loan broker companies. They have already helped thousands of people get the best loan that suits their needs, and they can do the same for you.

Choosing an independent loan broker means they won’t proceed with an application unless they are sure it is in your best interests. They are also regulated by the FCA, which gives you an additional layer of protection.

If you would like to speak to one of these loan brokers who can help you get a loan, then click on the below and answer the very simple questions.