1. Payment Shock. One major risk is that your monthly payment may increase by a large amount, resulting in "payment shock." Even a change of 1% or 2% in interest rates can result in a very big jump in your monthly mortgage payment. For example, if the interest rate on your mortgage changes from 4% to 6%, your monthly payment could rise by as much as 50% (from $1,000 to $1,500). If your income has not increased enough, you may not be able to afford the new larger monthly mortgage payment. And if that happens, you could lose your home.
Example: How Payment Shock Can Occur
Assume you buy a home for $300,000, put 10% down, and choose a 5.75% interest-only adjustable rate mortgage. The mortgage requires interest-only payments for 5 years.
After that, the interest adjusts every year based on rates in effect at that point.