for buying your home under a combo fixed and adjustable
rate plan
Why
Homeowners Select this Type of Mortgage Loan
•
Less
Risk:
usually
has a lower rate than fixed-rate loans plus
lower risk that the 1-year ARMs
•
Temporary
Loan:
consumers
select the Hybrids when they will be in the
home for a select period of time
•
Loan
Qualifier:
homeowners
use the Hybrid to lower their rate and to qualify
for larger loan amounts
•
Assumable
Loans:
Hybrids
and ARMs that are generally assumable when selling
your home
•
Rates
can Decrease:
ARMs
rates can decrease in declining interest rate
markets
Disadvantages
of this Type Loans
•
Additional
Costs:
hybrid
rates are typically higher than 1-yr ARMs
•
Rates
can Increase:
rates
will adjust at the end of the initial period
which could raise your payment
•
Hard
to Budget:
interest
rates will adjust annually after the initial
period making it hard to plan your finances
•
Payments
Can Increase:
in
rising interest rate markets, your monthly payment
can increase significantly after the initial
fixed-rate period
Introduction:
Hybrid loans are a combination
of fixed rate and ARM loans. These ARMs
attach a delayed adjustment period during which
the initial period is fixed.
These loans carry less risk than 1-year ARMs
and the interest rate is generally
lower than fixed-rate loans.
Since many homeowners remain
into their homes for about 7-10 years, combination
loans allow buyers to take advantage of lower
interest rates in the first few years of the mortgage.
Types
of Hybrid Loans:
The basic types of hybrids
include the following:
30/3/1
30/5/1
30/7/1
30/10/1
Example: 30/3/1 ARM
is a 30 year loan with the interest rate and
payment fixed for the initial period of 3 years.
At the end of 3 years, the
interest rate and payment changes once each
year for the remaining period of the loan.
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. The higher the
delayed adjustment period, the higher the interest
rate.
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:
30/3/3
15/3/3
30/5/5
15/5/5
Example: 30/3/3 ARM
is a 30 year loan with the interest rate and
payment fixed for the initial period of 3 years.
At the end of 3 years,
the interest rate and payment changes
once every 3 years for the remaining period
of the loan.
15/5/5 ARM is a 15 year loan with an interest
rate and payment fixed for the initial period
of 5 years. At the end of 5 years, the interest
rate and payment changes once every 5 years
for the remaining period of the loan.
The challenge you 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 5 or
7 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.
The two-step mortgage is a 30-year mortgage
that generally comes with a lower interest rate
than the conventional 30-year mortgage.
The ARM Components of Hybrid Loans:
The ARM components
of the Hybrid include the following:
Index: the ARM
begins with a base number which is tied to
an published index that can go up or down.
Two widely used ARM indexes are the Treasury
Rate Index and Cost of Funds Index.
Margin: the margin
is the additional amount that the lender adds
to the index to derive the Interest Rate that
is charged for the loan.
The margin covers the lender's
cost and profit. The margin may varies
between 1.5 to 3.0 percentage points.
Initial Interest Rate:
the initial rate is the current prevailing
rate at the time that you lock-in your position,
which is generally one to three percentage
points lower than the prevailing 30-year fixed
loan rate.
New Interest rate:
the adjusted interest rate over the life of
the loan.
New interest rate is calculated at the time
of adjustment
New Interest Rate = index + margin
Adjustment Interval:
the time between the interest rate is scheduled
to change. The ARM can change every six months,
annually, every three years, or every five
years.
an ARM with an adjustment interval
of six months is called a 6-month
ARM.
an ARM with an adjustment interval
of 1 year is called an 1-Year ARM.
and so forth
At the time of adjustment,
your lender will recalculate your loan
payment under the new interest rate and remaining
term on the loan.
For example: let's
say that you close on 1-year ARM at 5.5% for
30 years. Your monthly payment during the
first year (full 12 months) will be as follows:
Borrows Amount:
$100,000
Interest Rate
5.5%
Payment Term
30 Years (360 months)
Monthly Payments Yr-1
$567.79
At the end of one year, your
ARM will adjust and reflect the new interest
rate. Your lender will then recalculate
your new monthly payment using a 29-year term:
Borrowed Amount:
$100,000.00
(less) principal
paid Yr-1
$1347.09
New Borrowed Amount
$98,652.91
New Interest Rate
6.0%
Payment Term
29 Years (548 months)
Monthly Payments Yr-2
$598.83
Interest Rate Caps:
interest rate caps protect the consumer
in the event that interest rates rise too
rapidly. There are lifetime caps and adjustment
rate caps. Make sure your understand these
caps when finalizing your loan decision.
Example
Life-Time Cap:
ARM index rate: 4.5%
ARM margin: 2.5%
Life-Time Cap: 4%
Interest rate: 7.0%
The ARM index has jumped to 8%
The new interest rate equals 8%
+ 2.5% = 10.5%
The life-time cap limits the new
interest rate to: 4.5% + 4% = 8.5%
Example Adjustment Rate
Cap:
ARM index rate: 4.5%
ARM margin: 2.5%
Periodic Adjustment Rate Cap: 1%
Interest rate: 7.0%
The ARM index has jumped to 6%
The new interest rate equals 6%
+ 2.5% = 8.5%
The adjustment rate cap limits the
new interest rate for the adjustment
period to: 4.5% + 1% = 5.5%
Payment Caps:
limits the payment amount the consumer needs
to pay at time of interest rate adjustments.
Note: payment caps may not provide enough
payment to cover the required interest charges
during rising interest rates. Under
this condition, the consumer will experience
negative amortization — where
the interest amount not covered is added to
the principal of the mortgage loan.
Example: if your
payment cap limits your monthly payment to
$1050 when the true payment should be $1250
due to ARM rate adjustments, the unpaid $200
will be added to the principal mortgage loan
balance for later payment.
Let
us find a lender near you with the best rate
and terms.
*The
recommended product, term and use are listed as illustrative
purposes on how you might use the equity in your home.
Please note that your circumstances may be different
and that the recommended product, term and use may not
fit your particular need.
Two widely used ARM indexes
are the Treasury Rate Index and Cost of Funds Index.
Lenders on the East Coast
and Mid-West typically use the Treasury Rate Index,
which indices are the weekly or monthly average
yields on U.S. Treasury securities.
These indexes reflect the state of the economy
and are more volatile as they move with the market.
The index rate (which determines the mortgage rate
that you pay) fluctuates daily
based on market conditions and economic indicators.
Nobody can predict how rates will move, but you
can get a good idea of what might
change rates by understanding elements that drive
economic conditions. These may include:
An assumability clause allows the seller
of the home to transfer the mortgage loan to the homebuyer.
This could be an attractive feature in the
sale of a home during high interest markets.
For example, if your ARM is capped at 1-2 points lower
than prevailing ARM rates, your mortgage loan has
value.
To illustrate this, let's say that interest rates
rise and the prevailing ARM rate is 11%. Your existing
ARM rate has risen respectively but has a maximum
rate of 9%. You can transfer the 9% capped ARM to
the new homebuyer.
This assumability feature can
become a selling point in the sale of your home.
Note on the other hand, that interest rate markets
have been relatively low since the late-1980s. The
new homebuyer can generally find an ARM that is as
low or lower than your current ARM. So
in low interest rate markets, the assumability clause
may not have value.
The convertibility clause allows the borrower
to convert their existing ARM over to an prevailing
fixed-rate loan. This may become an exercised
feature when interest rates begin to rise rapidly.
The convertibility feature does
have its cost, however. First, your conversion
rate on a fixed-rate loan is generally higher than
your current ARM rate. Second, lenders may tack on
the conversion rate an additional margin as compensation
for the convertibility feature. Make
sure your read the fine print.
Teaser Rates: some lenders
will entice borrowers with a teaser rate. Note that
at the end of the teaser rate, lenders typically adjust
the rate to the maximum amount. Make sure you calculate
your monthly payment at the potential maximum rate.
Payment Recalculations:
at each adjustment period, lenders must recalculate
your monthly payment at the new rate, remaining term,
and existing mortgage balance after all existing payments
and pre-payments made on the mortgage loan.
Lenders do make mistakes and overcharge ARM borrowers.
You should double check the
banks calculation to make sure you are not
overpaying or underpaying your ARM mortgage. This
requires you to calculate your new payment with the
new rate (based on prevailing index and lender margin),
remaining term and mortgage balance.
Download our amortization worksheet to help you in
that calculation: click
here.
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