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What is a Straight Loan in Real Estate?

Published by
Camilla Smoot
Edited by
David Hodges
Fact checked by
Andrew Latham
    • Article Summary:

    With a straight loan, the borrower only makes interest payments until the maturity date. No money is put toward the principal balance before then. Once the maturity date arrives, borrowers must either refinance their loan or pay off the entire balance.

    As you’ve begun your journey toward owning a home, you’ve probably looked into conventional loans, FHA loans, or VA loans. But have you ever heard of straight loans? Before the Great Depression, straight loans were the main type of mortgage loan borrowers would use. Since then, however, straight loans have become more of an anomaly. However, they are still used occasionally to purchase property, so they’re worth knowing about and looking into. Although a straight loan is a niche product in today’s market, it might be the loan you need.

    What is a straight loan?

    Straight loans only require the borrower to pay the interest on the loan until the maturity date. None of the payments go toward the principal amount. When the maturity date comes, the borrower will make the final interest payment. At that point, a straight-loan borrower must either pay off the outstanding loan balance or refinance the loan. These loans are sometimes referred to as straight-term mortgage loans or term loans (though the latter can be misleading because many other loans are also term loans).

    Straight loans were the most common loan before the 1930s mortgage crisis. Since then, conventional loans have been borrowers’ go-to choice for mortgage loans. Today, straight loans are generally only used for construction and land development. Real estate investors who buy, renovate, then resell properties quickly (“house flippers”) may also find these interest-only loans appealing.

    The differences between straight loans and other loans

    Straight loans are special-purpose loans, meaning they are used for personal or business investments. This is one characteristic that makes straight loans different from other types of loans. Another big difference with straight loans is that only interest payments are made. Payments on the principal balance are not made until a straight loan reaches its maturity date.

    Here’s a breakdown of the differences between straight loans and three major types of loans:

    Conventional loans

    Unlike with straight loans, borrowers make a down payment with conventional loans. Borrowers also make both the principal and interest payments from the beginning with conventional loans. So, your monthly mortgage payment will go toward both your principal balance and interest. Lastly, conventional loans are long-term loans, while straight loans have a short turnaround time. Common conventional loan terms are 15 and 30 years.

    Government-backed loans

    Mortgage loans backed by the Federal Housing Administration (such as VA and FHA loans), the U.S. Department of Agriculture, and the Small Business Administration are all government-backed loans. If the borrower defaults on one of these loans, the government has to pay the lender and the borrower will be in debt to the government. You must also make a down payment and principal payments in addition to interest payments on these loans. Similar to conventional loans, government-backed loans have a longer pay-off period than straight loans. Government-backed loans usually have a longer term, in the same 15–30 range as conventional loans, though supplementary loans with government backing may have shorter terms.

    Pro tip: FHA, VA, and conventional loans are three common types of mortgage loans. Each is different and has its own benefits. You can learn the differences and determine which is best for you by reading SuperMoney’s guide to FHA, VA, and conventional loans.

    Seller financing

    While straight loans are lent through lenders and investors, seller financing is when a homeowner finances a loan for the buyer. Seller financing also involves a down payment, interest payments, and principal payments.

    Tabular summary

    Here’s a recap of the main points of just covered, plus one or two extra bits of bonus information:

    Loan typeWho handlesGovernment guarantee protects the lenderDown paymentLoan paymentsTerm
    StraightBank, credit union, or another lenderNoNoInterest onlyShorter, 3–5 years
    ConventionalBank, credit union, or another lenderNot directly, but sometimes indirectly.YesPrincipal and interestLonger, 15–30 years
    Government-backedBank, credit union, or another lenderYesYesPrincipal and interestLonger, 15–30 years
    Seller financingArranged between sellers and buyersNoYesPrincipal and interestVaries

    How long are straight loans?

    Straight loans are short-term loans. The average duration of a straight-term loan is from three to five years. This differs from other loans, which usually have terms anywhere from 10 to 30 years.

    When are straight loans used?

    While popular before the 1930s, straight loans aren’t typically used anymore. When they are used, it’s mostly for financing development loans. Development loans are a type of mortgage loan used for construction, excavation, and infrastructure on a property.

    The pros and cons of a straight loan

    Although they’re not commonly used anymore, there are still some reasons why one would be interested in a straight loan.

    WEIGH THE PROS AND CONS

    Here are a few benefits and drawbacks of taking out a straight loan:

    On the plus side
    • Lower monthly payments — When you take out a straight loan, you’ll be making interest-only installment payments. Because of this, your monthly payments will be lower than they would be with a conventional loan.
    • More cash flow — Because you’ll have lower installment payments, you’ll likely have greater cash flow. This could be beneficial for your budget.
    • Paid off faster — Having your loan paid off and out of the way is a huge stress reliever. Straight loans have a fast repayment period, with most usually being between three and five years. Because of this, your loan can be paid off in just a few years as opposed to 10, 20, or more years.
    On the minus side
    • No payments going toward the principal amount — A big drawback of a straight loan’s low monthly payments is that none of that money is going toward the principal balance. So, come the maturity date, you’ll have a hefty amount still left to pay.
    • Rise in interest rates — Changes in interest rates affect every loan with a variable rate, and an interest-only loan is no exception. If interest rates rise and you have a variable-rate loan, your monthly payments will also rise.
    • Shorter loan term — While this can be a benefit, it can also be a downside. A shorter loan term means that the maturity date comes faster. And when the maturity date comes, you’ll have to pay off the principal balance in its entirety or refinance the loan. You may not have as much time to accumulate enough money for the principal amount as you would with a conventional loan.
    Professionals’ tip: An “interest-only mortgage” combines aspects of a straight loan and a traditional mortgage. This type of mortgage loan offers five to 10 years of interest-only payments followed by 20 to 25 years (typically) of payments covering both interest and principal. In essence, this type of loan gives you a straight loan followed by a more traditional mortgage. Often, the interest rate is fixed during the interest-only period then variable during the principal-and-interest period, but almost any rate setup is possible. Learn more about mortgage types.

    FAQ

    Is a term loan the same as a straight loan?

    A straight loan is a term loan, so you will often find these terms referring to the same thing. Term loans are a broader category, however. In fact, most loans are term loans, and the loans most often called simply “term loans” are the business loans that fall into this category. Read more about term loan in the business context.

    You may also see a straight loan referred to as an interest-only loan or a straight mortgage loan.

    What type of loan is a straight mortgage?

    A straight mortgage loan is designed so that the borrower pays only the interest until the end of the loan term. These loans are also called term loans (true but vague) and straight loans.

    Are payments higher on a straight loan?

    Because you’re only paying interest, the monthly payments tend to be lower on a straight loan. Keep in mind, however, that these payments are not going toward your principal balance. You will still have to pay that off at the end of the term or refinance the loan.

    Key takeaways

    • Straight loans are designed, so the borrower only pays the interest on a loan until the maturity date.
    • When the maturity date occurs, the borrower either needs to pay off the entire principal amount due or refinance the loan.
    • Straight loans have a shorter term length than other loans, such as conventional and government-backed loans.
    • Today, straight loans are mostly used for development projects.

    Finding the right mortgage lender

    If you’re a potential homeowner, be sure to compare rates of at least three mortgage lenders before committing to one. Finding the right lender can help you find the best house for you and save thousands of dollars. It’s easy to do, and only takes a couple of minutes. Check out the best mortgage lenders here.

    View Article Sources
    1. Development Loan definition — Law Insider
    2. Evolution of the U.S. Housing Financing System — U.S. Department of Housing and Urban Development
    3. Interest-Only Mortgage Payments and Payment-Option ARMs — Federal Deposit Insurance Corporation
    4. The American Mortgage in Historical and International Context — University of Pennsylvania
    5. Useful background articles from Real Estate Words, other real estate sites, and online lenders — Various
    6. What is an “interest-only” loan? — Consumer Financial Protection Bureau
    7. What is an interest-only mortgage? — Chase
    8. Best Mortgage Lenders — SuperMoney
    9. Confused About Different Mortgage Types? Here’s How to Choose the Right One For You — SuperMoney
    10. FHA Loan vs. Conventional Mortgage: Which Is Right for You? — SuperMoney
    11. How Many Mortgages Can You Have?— SuperMoney
    12. How To Finance Multiple Rental Properties — SuperMoney
    13. The Definitive Guide to FHA Loans — SuperMoney
    14. VA vs. FHA vs. Conventional Loans — SuperMoney
    15. What Does Under Contract Mean in Real Estate? — SuperMoney
    16. What Is a Conforming Loan? — SuperMoney
    17. What Is A Participation Mortgage? — SuperMoney
    18. What Is a Term Loan? Definition and Examples — SuperMoney
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