Which statement accurately describes Principal and Interest (P&I) repayments compared with Interest-Only (IO) repayments?

• A. P&I reduces the loan balance over time.
• B. IO payments reduce the loan balance over time.
• C. P&I payments cover only interest.
• D. IO payments pay down principal faster.

Answer: (A)

The key idea is how each payment affects the loan balance. Principal-and-interest repayments include both interest due and a portion of the loan’s principal, so with each payment part goes toward reducing the outstanding balance. Over time this causes the balance to fall. Interest-only repayments cover the interest for the period, so they do not reduce the principal during that time—the loan balance stays the same until the interest-only period ends and principal starts to be repaid. Therefore, the statement that the balance decreases over time with principal-and-interest payments is correct. The other options misstates how IO and P&I behave: IO doesn’t reduce principal, P&I doesn’t cover only interest, and IO doesn’t pay down principal faster.