Can You Get Interest-Only Mortgages?

Interest-only mortgages represent a distinct type of home financing available to borrowers under specific circumstances. Unlike traditional mortgages, where payments immediately begin to reduce the loan principal, these loans are structured with an initial period focused solely on interest payments. While they offer certain advantages, they also come with particular conditions and considerations that borrowers need to understand. This financing option caters to a niche market, often requiring a strong financial profile from applicants.

Understanding Interest-Only Mortgages

An interest-only mortgage is a home loan where, for an initial defined period, monthly payments cover only the interest accrued on the principal balance. During this phase, the principal amount borrowed does not decrease, a concept known as principal deferral. This setup fundamentally differs from a traditional amortizing mortgage, where each payment includes both a portion of the principal and the interest, steadily reducing the outstanding loan balance over time.

This structure allows for lower initial monthly payments compared to a conventional loan. Payments exclude any contribution towards the principal. For example, if a borrower has a a $400,000 loan at a 6% interest rate, their interest-only payment would be $2,000 per month. The principal balance remains unchanged throughout this period.

The Interest-Only Payment Period

The interest-only phase of the loan has specific mechanics governing payment calculations and duration. Monthly payments are determined by applying the interest rate to the outstanding principal balance. For instance, a loan of $300,000 with a 5% annual interest rate would require a monthly interest payment of $1,250. This payment amount can fluctuate if the interest-only mortgage is an adjustable-rate mortgage (ARM), which most commonly are, meaning the rate may reset periodically.

This initial interest-only period typically lasts for a set duration, commonly ranging from three to 10 years. During this time, the principal balance of the loan remains exactly as it was at the loan’s inception, as no part of the payment is allocated to reducing it. While the monthly payment can be significantly lower than a fully amortizing loan, borrowers do not build equity through principal reduction during this phase.

Approaches to Principal Repayment

At the conclusion of the interest-only payment period, the loan transitions into a fully amortizing structure. This means the borrower must begin making payments that cover both the remaining principal balance and the interest. This transition typically results in a significant increase in monthly payments, as the original principal amount must now be paid off over the remaining, shorter term of the loan. For example, a 30-year mortgage with a 10-year interest-only period would require the full principal to be repaid over the remaining 20 years.

Beyond this mandatory transition, other scenarios for addressing the principal exist. Some interest-only loans may include a balloon payment, requiring the entire principal balance to be paid in a single lump sum at the end of the interest-only term. Alternatively, borrowers might choose to refinance the loan before or at the end of the interest-only period to secure new terms or a different repayment structure. Borrowers also have the option to make voluntary principal payments during the interest-only phase, which can reduce the outstanding balance, potentially lowering future interest-only payments or shortening the subsequent amortization period.

Qualifying for an Interest-Only Mortgage

Obtaining an interest-only mortgage generally involves meeting stringent eligibility requirements, as lenders consider these loans riskier than traditional mortgages. Borrowers typically need a strong credit profile, often requiring a credit score of 700 or higher. Lenders also look for higher income levels and a lower debt-to-income (DTI) ratio, frequently seeking a DTI of 36% or less.

A substantial down payment is often required, with many lenders expecting 15% or more of the home’s purchase price. Lenders may also require proof of significant assets or savings to demonstrate the borrower’s ability to cover potentially higher payments once the interest-only period concludes. These loans are typically offered to specific borrower profiles, such as those anticipating a significant increase in future earnings or real estate investors who plan to sell the property before the principal repayment phase begins. While less common than traditional loans, they are available through various lenders catering to these particular financial situations.