Hybrid loans are a combination of fixed rate and Adjustable Rate Mortgage (ARM) loans. These ARMs attach a delayed adjustment period during which the initial period is fixed.
Hybrid mortgage loans carry less risk than one-year ARMs and the interest rate is generally lower than fixed-rate loans.
Since many homeowners remain in their homes for about seven to10 years, combination loans allow home buyers to take advantage of lower interest rates in the first few years of the mortgage.
Benefits of Hybrid Mortgage Loans
- Hybrid mortgage loans give the homeowner a lower rate than fixed-rate loans and lower risk than the one-year ARMs.
- Many consumers select hybrids mortgage loans when they know they will be in the home for a select period of time.
- Homeowners use Hybrid loans to lower their rate and to qualify for larger loan amounts.
- Hybrids and ARMs are generally assumable, which is a plus when homeowners plan to sell in the near future.
- Adjustable rate mortgage rates can decrease in declining interest rate markets reducing your loan payment.
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Disadvantages of Hybrid Mortgage Loans
- Hybrid mortgage rates are typically higher than one-year ARMs.
- Rates will adjust at the end of the initial period, which could raise your payment.
- Interest rates will adjust annually after the initial period making it hard to plan your finances. monthly payment can increase significantly after the initial fixed-rate period
Types of Hybrid Mortgage Loans
The basic types of hybrids include the following:
A 30/3/1 ARM is a 30-year loan with the interest rate and payment fixed for the initial period of three years. At the end of three years, the interest rate and payment changes once each year for the remaining period of the loan.
A 30/10/1 ARM is a 30-year loan with an interest rate and payment fixed for the initial period of 10 years. At the end of 10 years, the interest rate and payment changes once each year thereafter for the remaining period of the loan.
The 30/3/1 will have a lower initial rate than the 30/5/1. Basically, the higher the delayed adjustment period, the higher the interest rate will be.
There are also hybrids at:
- 15/3/1
- 15/5/1
- 15/7/1
- 15/10/1
These are the same loans with 15-year terms instead of 30 years.
Some hybrids come with longer adjustment periods. The most common are:
- 30/3/3
- 15/3/3
- 30/5/5
- 15/5/5
A 30/3/3 ARM is a 30-year loan with the interest rate and payment fixed for the initial period of three years. At the end of three years, the interest rate and payment changes once every three years for the remaining period of the loan.
A 15/5/5 ARM is a 15-year loan with an interest rate and payment fixed for the initial period of five years. At the end of five years, the interest rate and payment changes once every five years for the remaining period of the loan.
The challenge you will have with this extended adjustment intervals is the timing of the interest rate market.
If interest rates shoot up at the end of your initial fixed-rate term, your adjustment rate will be set at a high rate during the period you selected. Likewise, if interest rates decline, you could set yourself in a nice interest rate position.
Two-Step Mortgage
The two-step mortgage comes with an initial fixed rate for a period of five or seven years. At the end of the period, the rate will adjust to market conditions and remain the fixed rate for the remaining term of the loan.
