What is a hybrid adjustable rate mortgage?

Hybrid Mortgages

By Mark Barnes

Direct Lending Solutions Staff Writer

Unlike the standard adjustable rate mortgages you may already know about (the 1-year, 3-year and 5-year), the hybrid ARM comes with terms of 7 and 10 years and some very intriguing interest-only options. These are excellent loans if you believe you’ll be in a home for no more than this amount of time or if you want to save huge dollars monthly and yearly.

If done properly, and with full payment capability (appropriate income), you can save thousands of dollars in interest over the life of this loan, and you don’t have to worry about the adjustment period, if you move prior to the end of the 7 or 10 years. The type of hybrid adjustable rate mortgage, which some experts warn most heavily against, is the one with an initial period of interest-only payments, prior to changing to a low fully-amortized adjustable rate. This ARM might offer a 5-year term with interest-only payments. In the 61 st month, however, it changes to a 1-year LIBOR rate.

Using an example of a $333,700 home loan, from a related article at Realty Times, this model shows a change in payment, after the interest-only period of $435 – from $1,460 to $1,895. Keep in mind, this is after five years. Now, if the home owner had initially taken a fixed-rate loan at 6.25%, she would have paid $2,054.65 in monthly principal and interest, every month she had the home loan.

In the first five years, she would have paid $123,279 for her home. With the interest-only hybrid adjustable rate mortgage, she will pay just $87,600 in the same period, a difference of $35,679. In the sixth year, or the 61 st month, the payment on the ARM goes adjusts to $1,895. Sure, this is a considerable hike of $435, but it’s still $159 less than the fixed rate and an additional savings of $1,908. This brings the six-year savings in this hybrid ARM program to $89,508 – an average yearly savings of nearly $15,000.

So, as long as the home owner had originally calculated paying a fixed-rate mortgage (the much higher payment), this $435 increase will be very manageable. The naysayers will say that the interest-only hybrid ARM doesn’t allow for equity building. The phrase building equity in a home, when using standard mortgage payments, is really a misnomer. Using the previous model, the home owner would only reduce the principal balance on the mortgage by $23,000 in six years. So, considering equity, when deciding on a mortgage program is a difficult course to navigate. In fact, although she may not reduce the mortgage by paying interest only, her home’s value will increase by at least $70,000 on simple appreciation, alone.

If principal loan reduction is the goal, then the hybrid adjustable rate mortgage is likely the wrong program. However, a standard fixed-rate program would also be a poor choice. All home loan programs have good and bad qualities. The key is knowing what you want.

If the goal is monthly and yearly savings, with little elimination of principal mortgage, the hybrid ARM is a wonderful program.

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