Are you shopping for a mortgage to finance a home that you expect to own for no more than a few years? If so, you should know about a hybrid mortgage. Hybrid loans give prospective home buyers the ability to buy a lot more home than they can afford-thanks to the initially lower interest rate.
But with such flexibility comes greater risk. Since lenders are free to design loans to fit borrowers' needs, the terms and fees vary widely and homeowners can get burned if rates climb higher.
Hybrid mortgages allow homeowners to benefit from the best aspects of both fixed-rate and adjustable-rate mortgages (ARMs). With hybrids, borrowers choose to accept a fixed interest rate over a number of years-usually, 3, 5, 7, or 10 years-and afterward the loan converts to an ARM. But therein lies the danger: While you're getting an extraordinarily low rate up front for a few years, when the fixed-rate period expires you could very well end up paying more than double your current rate of interest.
At a rate of 6.16% for a 30-year mortgage, for example, a person borrowing $200,000 would pay $ 1,220 a month. With a seven-year hybrid, more commonly called a 7/1 loan, at the going rate of 5.61%, that monthly payment drops to $ 1,150. By the end of the seventh year, the homeowner would save about $7,700 in interest charges by going with a seven-year hybrid. To say that there are drawbacks is an understatement. Despite the surge in popularity, a hybrid loan can be a ticking time bomb for borrowers who plan on holding the loan for the long term. Discuss the potential drawbacks associated with the hybrid ARMs by giving a specific loan and interest rate scenario.