An interest-only mortgage can become an albatross if you don't refinance the principal balance. The preferred way for many lenders to convert an interest-only loan to a traditional mortgage is through refinancing. You will obtain an amortizing loan that will replace the interest-only one. Once you close, your old loan will be paid off, and you'll make monthly payments of both interest and principal to reduce the balance over time.
When to Refinance
Interest-only loans are good for people with infrequent or sporadic income streams. This includes individuals whose income is primarily derived from bonuses, commissions or temporary employment. The lower payments are more manageable on limited income. An interest-only loan will often convert to amortization after a period of time. If you have the ability to refinance, take advantage of it. Until you switch to an amortizing loan, you will simply be making payments each month without progress.
Research lenders to find one that suits your need. Compare rates, terms and fees. Once you find an appropriate lender, fill out an application. Indicate clearly that you will be paying off your interest only loan with the proceeds. Provide supporting documentation as required. Most banks require two years of W-2 forms and federal tax returns along with one month of pay stubs.
The bank will run your credit report to determine if you have a good history of repayment. It then tallies up your monthly debt and compares it to your income. It will also include the new payment in your debt, which will be significantly more than your interest-only obligation. You need to show steady income and stable employment. The bank will also ensure that the value in your property is sufficient to support the loan. If you meet the criteria, the bank will approve your loan and send you a commitment letter.
Your commitment letter will outline the terms and conditions of the loan. You will coordinate a closing date with the new lender to sign the appropriate documents. Contact the lender for your interest-only loan and request a payoff figure -- the total amount needed to satisfy the loan -- through the date of closing. Attend closing and sign the documents. Your new lender will send the money to pay off the existing bank. Once the existing bank receives the money, the interest-only loan will be closed, and you will begin repaying your traditional mortgage.