Interest-only (IO)

Definition

Interest-only (IO) in plain English

When loans are packaged into bonds, the payments borrowers make split into two streams: interest (the rent charged for borrowing) and principal (paying back the original amount). An interest-only bond is a slice that collects only the interest stream, never the principal repayments. That makes it a bit of a gamble on time: if borrowers pay off their loans early, the interest stops flowing and the IO holder gets less than hoped, so its value swings sharply with how fast people repay. It's the opposite twin of a principal-only bond, which gets only the payback amounts.

Learn these first

• Pooling and servicing agreement (PSA)
• Securitization

Practice Interest-only (IO)

Which vehicle was specifically created by the Tax Reform Act of 1986 for this asset class?

Related Asset-Backed Securities terms

• Absolute Prepayment Speed (ABS)
• Advance rate
• Appraisal Reduction Amount (ARA)
• B-piece
• Basis risk
• Commercial Mortgage-Backed Security (CMBS)
• Conduit CMBS
• Controlled amortization
• Controlling class
• Cross-collateralization