How to Change to an Interest-Only Mortgage
An interest-only loan is a conventional mortgage (not a government backed or insured loan such as FHA or VA) with an added feature that allows the borrower the option of paying only the interest owed each month, for a period of time. The advantage of interest only is that the payment is lower. The savings in payment frees up cash flow for the borrower, allowing him to use those funds in any way he chooses. The disadvantage is that unless additional funds are paid on the mortgage, the balance does not decrease and you gain no equity. Changing to a loan with an interest-only feature when you are in a traditional fixed rate or ARM (adjustable rate mortgage) will require a complete refinance to accomplish.
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Things You'll Need
- Income information
- 2 year's W2s
- 30 day's paystubs
- Copy of deed
- Copy of survey (if applicable)
- Homeowner's Insurance Declarations Page
- Credit report
Instructions
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Call a realtor in your area and ask them to do a "sold search" on their MLS system in your neighborhood to get an idea of what your home may appraise for. You must have enough equity in your home to refinance and roll closing costs into the loan (unless you prefer to pay closing costs "out of pocket.") From the list of sold properties in your neighborhood, choose the ones closest to yours in size, room count and number of baths and see what they have sold for. These sold properties will most likely be used as comparables when an appraisal is done on your property. Your value will fall somewhere close to the sold amounts in your area.
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2
Go online to view your personal credit reports (see References). Check to see if anything has hit your reports that might injure your credit scores or if something is in need of dispute. Doing these two things upfront will save surprises later. If the credit reports show no surprises and the value in your home is sufficient, proceed to talking with your lender.
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Call your lender (mortgage bank or broker) and discuss options for refinancing using an interest-only loan. Let the lender know the sale prices of homes that have sold in your area and that your credit should be fine. Your target should be to pay off your present loan, add the closing costs to the balance and not exceed 80 percent of the appraised value to avoid paying private mortgage insurance. If the lender feels your new "loan to value percentage" is workable, get a quote of interest rate, costs to close and compare payments. (example: a $200,000 loan with a 30-year fixed rate at six percent gives an amortized (principal and interest are paid) payment of $1199.10. Interest only requires a payment of $1,000). If it all sounds workable, make an appointment to do an application.
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Meet with your lender. Provide your lender with all information needed for the application. Provide income documents, copy of deed, insurance information and any other information the lender may require. Provide lender with the name of the closer you used for the last closing on your home. Your lender will be able to run an automated underwriting service (a computerized approval service) on your loan and give you the results in a couple of days. The lender will coordinate with the closer and order your appraisal as part of processing the loan, which takes about 30 days. Discuss locking in the rate.
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Schedule appraiser's appointment when he calls and follow up with your lender to provide updated paystubs or any missing documents as requested. When the appraisal comes in to the lender, the lender should be ready to submit the entire package to underwriting. The underwriter will complete the approval process and issue a "Clear to Close" transmission to the lender when finished. You are now ready to close your new loan. Request a closing statement prior to closing to go over the closing figures. Ask your lender questions regarding anything you do not understand.
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Attend closing as scheduled by your lender with your closer. Read and ask questions regarding documents and anything you do not understand, as the lender goes through each document. Sign and date as the closer instructs you. You have now accomplished closing your new loan with interest-only feature, but the payoff to your old lender will not be sent out for three business days. This is called a three-day recessionary period, which federal law provides for you just in case you feel you have made a mistake and wish to change your mind.
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Tips & Warnings
Interest-only loans work well for borrowers who are commissioned sales employees with periodic additional pay or bonuses. They use the extra funds to pay against the principal balance to create equity in their property.
Interest-only loans will not build any equity in your property if no additional payments are made to reduce the principal. These loans will remain at interest only for a fixed period of time (10 full years), then roll (change) to an amortized loan (where principal and interest is paid) for the remaining 20 of the 30 year term This will always cause the payments to increase drastically. There is usually a "pricing adjustment" for the "interest only" feature, making your interest rate slightly higher than it would be without this feature.
