[Fan of Fiat]

Why is an interest only ARM riskier than a standard ARM?

[Moonman62]

Supposedly it doesn't build equity as fast, but in the first few years of a loan, equity doesn't build much anyway, even with a fixed rate mortgage.

[RebelBanker]

An interest only loan depends on the property gaining in value for the owner to be able to recover his investment (after selling costs). If the value declines, the loan could easily be greater than the value - a condition known as "under water." If the owner is paying down principal on the loan, he is building equity in the property which can keep the loan to value OK.

[Montana4Jesus]

As long as the individual borrower is in an appreciating market an I/O Arm is not riskier. Unfortunately there are a lot of people who listen to the talking heads on Saturday morning and think that they know something about the mortgage industry. I have worked in the secondary market mortgage industry for 15 years and can tell you that the benefits far out way the costs. Option Arms on the other hand do have some serious down sides if they are not handle properly, however can also be a powerful tool in money management if the borrower is investment savvy and in an appreciating market.

[WashingtonSource]

Because after the initial period of interest only, usually five years, the interest adjusts and the borrower starts to pay interest and principal. Most formulas would give borrowers a higher interest rate even if interest rates had not changed (based on a short-term rate plus a margin, often 2 percentage points or more). The principal addition to the payment is based on amortizing the loan over 25 years instead of 30, since no amortization occurred in the first 5 years. With a higher interest rate plus a principal payment when the loan resets, payments can jump 50 percent or more. If home prices are flat and falling the borrower can not refinance out of the loan to keep the payment low with a new IO or some other loan.