As for interest-only mortages being a problem, they were a much bigger problem than normal loans were- because they depend upon your income not only remaining level, but actually increase with respect to inflation. So it’s not enough to just stay in place, you have get ahead.

Ignore, for a minute, that this argument wasn’t made by the Wikipedia article, and that the catastrophic loss of earning potential for the average worker in the Great Depression didn’t make even regular home loans impossible to manage. Instead, let’s look at what you said as a general concept.

You are certainly right — the idea that interest-only mortgages are a way to “buy more than you normally can” or “leverage your future earnings” is just flat-out rabid consumerism. To that extent, interest-only mortgages can be the rope which you hang yourself with.

On the other hand, there are certainly useful times for interest-only mortgages. It’s a great option for families refinancing who want to put money away now for a kid’s college — it allows you to pre-allocate about $12k over the course of 5 years to go into college funds, and in 5 years (when the kid is already in college), the higher payments shouldn’t phase you much. Yes, you could pull the money out in terms of a home equity loan when the kid goes to college, but then you’re A) looking at much higher payments overall, B) depending on rates to as low then as they are now, C) limiting your potential earnings to $12k in 5 years as opposed to investing that money, and D) going to have to pay to get at that equity.

It’s also a good method for people who buy a fixer-upper to buy some time to pay for the improvements. It works just like the people saving for student’s college, except the money goes into capital improvements instead of some return-generating fund.

Note that both previous cases assume that the person getting the mortgage can afford the higher (post-reamortized) rate, and are choosing to use the difference between the interest-only and post-reamortized rate for some kind of fiscally sound reason.

It’s arguably good for anyone who intends to sell before the re-amortization period arives, since the principal pay-off in the first few years is relatively minor, although the very cost of buying and selling the property makes me suspicious at the numbers compared to renting.

I’ve also seen it used as a way to leverage a rental property’s value to generate cash flow, but that requires that when the interest-only period is up, the owner either A) has escalated rent to the

And, of course, both interest-only mortgages and their scary cousins — negatively amortizing mortgages — are useful for flippers, who are happy to pay as much as possible at closing in order to keep their holding costs down.

The problem is if there are large numbers of defaults at the same time (or near enough). Then this risk sharing could bring everyone down simultaneously.

This, of course, is no different between regular loans and interest-only loans.

As for interest-only mortages being a problem, they were a much bigger problem than normal loans were- because they depend upon your income not only remaining level, but actually increase with respect to inflation. So it’s not enough to just stay in place, you have get ahead. If you don’t, you’re screwed. And so is your lender, as well. If you just give up and mail the keys to the bank, the bank now owns a home it a) doesn’t want, and b) paid way to much for. Remember the bank’s out the money it loaned you- and in this case, it’s basically gaurenteed the house isn’t worth that much anymore.

Except now things get complicated. One of the reasons the banks are willing to provide much more risky loans (well, other than the competitive pressure of cheap money) is that they think they are selling the risk to someone else- i.e. they’re risking someone else’s money. See, they immediately sell your loan to a mortage company, which packages your loan with a lot of others into a basket, and sells shares of the basket to hedge funds (not Jane St.), who buy the shares with money invested in them from “fund of funds” mutual funds, which are, um, heavily invested in by banks.

What happens in practice here is that all the different layers of aglomeration and parcelling out tends to do is spread risk around- reward as well. So small amounts of loss tend to be shared by large numbers of people. If you default on your loan, a lot of people get hurt a little bit. Combined with reversion to the mean, this makes people think they have eliminated risk. The problem is if there are large numbers of defaults at the same time (or near enough). Then this risk sharing could bring everyone down simultaneously.