Can I Get an Interest-Only Mortgage?

An interest-only mortgage allows borrowers to pay only the interest accrued on the loan for a predetermined period. This contrasts with traditional amortizing mortgages, where each payment simultaneously reduces both the principal balance and covers the interest. During this initial phase, the monthly payments are typically lower.

How Interest-Only Mortgages Work

An interest-only mortgage is structured in two distinct phases. During the initial “interest-only phase,” which typically lasts between three and ten years, monthly payments are calculated solely on the interest accrued on the principal balance. This means the principal amount does not decrease during this period. The interest rate during this phase can be either fixed or adjustable, with most interest-only mortgages being structured as adjustable-rate mortgages (ARMs).

Once the interest-only period concludes, the loan transitions into its second phase, becoming a fully amortizing loan. Payments are recalculated to include both principal and interest for the remainder of the loan term. The monthly payment amount significantly increases in this repayment phase because the principal must now be paid down over a shorter remaining period. For example, if a 30-year mortgage has a 10-year interest-only period, the entire principal balance must then be repaid over the remaining 20 years.

What Lenders Look For

Lenders consider interest-only mortgages to carry a higher risk compared to conventional loans, leading to more stringent qualification criteria. A strong credit score is typically required, often above 700, though some non-qualified mortgage (non-QM) lenders may accept scores in the high 600s or lower if other financial strengths are evident.

Debt-to-income (DTI) ratio is another factor, with lenders generally seeking a ratio below 36%, though some may accept up to 43%. This ratio assesses a borrower’s ability to manage existing debt alongside potential mortgage payments. Lenders also often require a higher down payment, commonly at least 15% to 20%, or more, to mitigate their risk. Borrowers are frequently expected to demonstrate substantial assets or reserves, providing proof of financial stability and the capacity to cover payments, particularly if income fluctuates.

Applying for an Interest-Only Mortgage

Beginning the application process for an interest-only mortgage involves identifying lenders who offer these specialized products, as they are less common than traditional mortgages. Mortgage brokers or larger financial institutions might be good starting points for finding suitable options. Once potential lenders are identified, borrowers can pursue pre-qualification or pre-approval, which provides an estimate of the loan amount they might qualify for based on preliminary financial information.

The formal application requires a comprehensive submission of financial documentation to the lender. This typically includes proof of income, such as recent pay stubs, W-2 forms for employed individuals, or two years of tax returns for self-employed applicants. Lenders will also request bank statements and other asset documentation to verify reserves and financial stability, which can include investment accounts or retirement funds. A credit report is also pulled to assess creditworthiness, and a government-issued photo ID is necessary for identity verification. After submission, the loan application enters the underwriting phase, where the lender thoroughly reviews all provided documents and assesses the overall risk before making a final loan approval decision.

Managing Principal Repayment

During the interest-only phase of the mortgage, the original principal balance of the loan remains unchanged, as payments are directed solely toward the interest accrued. While not required, borrowers often have the option to make voluntary additional principal payments during this period. These extra payments directly reduce the outstanding principal balance, which can lead to lower future interest costs and a reduced payment amount once the loan transitions to its amortizing phase.

Upon the conclusion of the interest-only period, the loan converts to a fully amortizing structure, and monthly payments increase significantly. Strategies for managing this transition or reducing the principal can include making lump-sum payments from sources like bonuses or tax refunds, or considering a refinance of the loan before the interest-only period ends. It is important to clearly specify to the lender that any extra payments should be applied directly to the principal to ensure they reduce the loan balance effectively.