DEFINITION of 'Payment Shock'

The risk that a loan's scheduled future periodic payments may increase substantially. Payment shock can be the result of several things, including the expiration of an initial or temporary start interest rate (sometimes known as a teaser rate), the end of a fixed-interest rate period, the end of an interest-only payment period, an increase in an adjustable-rate mortgage's fully indexed interest rate or the recasting of a payment option ARM.

BREAKING DOWN 'Payment Shock'

Many popular mortgage products, such as payment option ARMs, carry a great deal of payment-shock risk. Consumers are drawn to these mortgages because of the relatively low initial monthly payments they offer. All financial decisions, including the choice of a mortgage, should be made by carefully considering the risk versus the reward. Risks must be identified and measured through insightful analysis. When risks, such as payment shock, are recognized and measured, they can be managed or avoided.

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