First, interest-only loans are dangerous for borrowers who don’t realize the loan will convert. They often cannot afford the higher payment when the teaser rate expires. Others may not realize they haven’t got any equity in the home and if they sell it, they get nothing.
The second disadvantage occurs for those who are counting on a new job to afford the higher payment. When that doesn’t materialize, or if the current job disappears, the higher amount is a disaster. Others may plan on refinancing, but if interest rates rise, they can’t afford to refinance, either.
The third risk is if housing prices fall. That hurts homeowners who plan to sell the house before the loan converts. In 2006, when the housing boom ended, many homeowners weren’t able to sell because the mortgage was worth more than the house.
The bank would only offer a refinance on the new, lower equity value. Homeowners that couldn’t afford the increased payment were forced to default on the mortgage. Interest-only loans were a big reason so many people lost their homes.