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Hybrid Mortgages: Worth Checking Out, But Not For Everyone

If you ask most people whether you should get a hybrid, I’d be willing to bet that they would start on a discussion involving the pros and cons of getting a Prius versus a Chevy Volt. But when you mention it to your loan officer, they are talking about Hybrid Adjustable-Rate Mortgages (unless your loan officer also doubles as a car salesman – in which case I’m not sure what type of bank you’re going to).

So what are these hybrids if they have nothing to do with getting better gas mileage? Hybrid mortgages are adjustable rate mortgages with an initial period (usually 5, 7, or 10 years) with a fixed interest rate. After the initial 5, 7, or 10 years the interest rate begins to adjust annually according to the index rate plus the lender’s margin (meaning the amount that the bank makes in profits). Usually, when people are talking about an ARM, they are really referring to these Hybrid loans.

The downside to this type of mortgage is that the borrower runs the risk of having interest rates increase. Even an interest rate hike of, say, 3 percent might make the loan unaffordable for the borrower. When you pile on the possibility of a decline in housing prices, unexpectedly ending up unemployed, or any number of life-altering calamities, borrowers run the risk of having the home they worked so hard for end up in foreclosure. Scary stuff.

Despite these obvious drawbacks, some borrowers might find a hybrid ARM to be just what they are looking for. Why is that? For one, the interest rate during the initial term of a hybrid ARM is considerable lower than the rates for their fixed-rate counterparts. As of July 17, 2015, the average interest rate on a 7/1 ARM (meaning that the interest rate is fixed for the first 7 years of the loan term and adjusts every year after that) was 3.31%. Compare this to 30-year fixed-rate mortgages, which were sitting at 4.07% on the same day.

While this isn’t a great choice for the vast majority of borrowers (especially in light of rising mortgage rates), it is perfect for borrowers that are only looking to stay in their new home for a short period of time. See as not many people stay in their home longer than five to seven years before selling or refinancing, a hybrid loan can be a smart move to save money in the first few years of homeownership; I’m looking at you first-time homebuyers.

That is not to say that you should spin the wheel with a hybrid loan if you are banking on a big pay raise within the next few years, because – like it or not – that may not happen. But for those that are looking at starter homes or will likely outgrow their home as their family grows – by all means – go to town.