Purchasing a new home stretches most people to the edge of their means. Fairly recently, it's becoming more common again to get an interest only loan. Typically, your mortgage payment is made up of two parts:
- Principle - Principle is the amount of your monthly payment that is going directly to decrease the total amount of your loan.
Interest - This portion of the payment goes directly to the bank on a monthly basis. It does not lower the amount due on your loan.
While you may also have an escrow account set up for property taxes and insurance, this portion of your payment will not be affected by an interest only loan.
An interest only loan is a loan that will eliminate the principle payment made on a monthly basis. If you have a $200,000 mortgage loan, you will pay only interest on the $200,000 and will not be paying anything to lower the amount of your loan. There are several reasons that one may select an interest only loan. Some of the more common include:
- Lower monthly payments - Without paying the principle on a monthly basis, you can save hundreds of dollars on your mortgage. This will allow you to afford more home than you would be able to buy with a traditional mortgage.
Dramatic increase in property values - When property values are increasing at a very steady pace, some people choose an interest only loan gambling that property values will continue to go up and they will build equity, regardless of the principle owed on the mortgage.
There are some downsides to an interest only loan.
- They are typically variable rate. What this means is that your mortgage rate may increase on a monthly basis after an initial locked period, typically three to five years. A higher interest rate can make significant changes to your monthly payments.
You are not paying down the principle. Most mortgages are designed to pay off the original principle of the loan in 15 to 30 years. With an interest only loan, you will owe as much on the house in five years as you do the day that you make the purchase.
You may be upside-down on the loan if property values decline. It is possible that property values will decrease, causing your principle owed to be higher than the actual value of the home. You will still be responsible for repaying the entire principle if you decide to sell the home, regardless of the sale price.
When you apply for the loan, you should prepare yourself with some documentation. If you have the following ready, you should have most of what you need.
- Previous Bank Statements - You will be asked for bank statements, possibly for the prior year.
- Current paycheck stubs - Plan to have the past two months worth of check stubs showing you monthly income.
- Documentation on other income - If you have another source of income, prepare yourself with documentation to support the income.
- Prior years W2's and other tax forms - Like the other financial statements, you should have your last two or three years W2's ready when you apply for the loan.
- Legal documentation to prove who you are - This may be a passport or drivers license, depending on the state.
So how can you get an interest only loan if you have determined it is right for your personal situation? There are three common ways.
- In person - The traditional method of getting a home loan. Visit your local bank or savings institution and speak with a loan specialist. They will walk you through the process to get a mortgage loan. There will be some paperwork to fill out as well as documents you need to provide including financial documents.
Over the phone - Many banks now offer mortgage quotes over the phone. You can contact banks and financial institutions by phone to speak with a mortgage loan specialist. You will then complete paperwork and mail or fax it in for review.
On the internet - The modern way of getting a loan. Almost all major banks will quote loans and take your application over the internet. After filling out the application, you will be asked to submit a packet of financial documents for review by mail.
Once you have completed any of the three above steps, you will need to sign some standard mortgage paperwork and you'll be on your way to an interest only loan.