Can I Change My Mortgage to Interest Only?

An interest-only mortgage offers flexibility by reducing immediate monthly expenditures and managing cash flow. This loan structure provides temporary relief by lowering required payments.

Understanding Interest-Only Mortgages

An interest-only mortgage is a home loan where, for a defined period, monthly payments cover only the interest accrued on the principal balance. No portion is allocated to reducing the principal, meaning the original loan amount remains unchanged. This period typically ranges from three to ten years.

During this phase, your payment is the outstanding principal balance multiplied by the interest rate, divided by twelve. For example, on a $300,000 loan at 5% interest, the monthly payment would be $1,250.

This contrasts with a traditional amortizing loan where each payment includes both interest and a small, gradually increasing amount of principal, steadily reducing the loan balance over time. You do not build equity through payments; equity accumulation only occurs if the property value increases.

Once the interest-only period concludes, the loan converts to a fully amortizing schedule. Monthly payments significantly increase as they must now cover both the remaining principal and interest over the remaining, shorter loan term.

Some interest-only mortgages may involve a large lump-sum payment, known as a balloon payment, at the end of the term. A clear strategy for principal repayment (e.g., savings, investments, property sale) is important.

Eligibility for Changing to Interest-Only

Switching an existing mortgage to an interest-only structure depends on lender policies and your financial standing. Lenders assess several key factors to determine eligibility, prioritizing the assurance that the full principal will ultimately be repaid. A strong credit score, often 700 or higher, is typically required.

Your loan-to-value (LTV) ratio is another important criterion. Lenders usually require significant home equity, often seeking LTVs below 80% or 75%. This provides them with a greater buffer in case of property value fluctuations. Your income stability and overall debt-to-income (DTI) ratio, ideally 43% or less, are also scrutinized to ensure you can manage current interest-only payments and the higher payments after the interest-only period ends.

The type of loan you hold also matters. Conventional loans may offer more flexibility for modifications compared to government-backed loans such as FHA or VA mortgages, which generally have stricter rules regarding changes to payment structures. Lenders will also require a credible plan for how the principal balance will be repaid at the end of the interest-only term. This “repayment vehicle” could include substantial savings, other investments, or the anticipated sale of the property.

The Application Process

Changing to an interest-only mortgage involves either a loan modification from your current lender or a refinance with a new one. A loan modification alters the terms of your existing mortgage, while a refinance replaces it with an entirely new loan. To begin, you should contact your current mortgage servicer to inquire about their specific options and requirements for an interest-only switch.

You will generally need to provide a range of documentation to support your request. This often includes recent pay stubs, the past two years of tax returns, and current bank statements, typically covering the last two to three months, to verify your income and financial reserves. Additionally, you may need to submit a current mortgage statement and details about your proposed principal repayment strategy. For a loan modification, you will likely complete specific forms provided by your lender.

The timeline for approval can vary significantly, usually ranging from 30 to 90 days, though more complex situations might take longer. If approved, you may enter a trial payment period, often lasting three months, during which you make the new, lower interest-only payments. Successful completion of this trial period leads to the permanent modification of your loan.

Financial Structure After the Change

Once your mortgage is successfully converted to an interest-only structure, the immediate financial impact is a reduction in your monthly payment obligation. This occurs because you are no longer making payments towards the principal balance; your entire monthly payment covers only the interest charged on the outstanding loan amount. This change can significantly free up monthly cash flow, providing temporary financial relief or allowing for reallocation of funds to other investments or expenses.

However, the principal balance of your loan will not decrease during the interest-only period. This means that at the end of this phase, the original amount borrowed, less any optional principal payments you might have made, will still be due. The total amount of interest paid over the life of the loan is likely to be higher than with a traditional amortizing mortgage, as interest continues to accrue on the full, undiminished principal balance for a longer duration.

When the interest-only period concludes, your mortgage payments will automatically transition to include both principal and interest. These new payments will be substantially higher than your previous interest-only payments because the remaining principal must now be amortized over a shorter timeframe. For example, if you had a 30-year mortgage with a 10-year interest-only period, the entire principal would then need to be repaid over the remaining 20 years, resulting in larger monthly installments. In some cases, the loan may require a balloon payment, requiring the entire principal to be repaid at once.