Fixed-Rate Mortgage or Adjustable-Rate Mortgage? Hybrids Are Both

Posted by  on Oct 25, 2010

According to Freddie Mac, the spread between adjustable-rate mortgage (ARMs) and fixed-rate mortgage rates is at its highest level in years. That means it may be much cheaper for you to consider an ARM loan instead of a fixed-rate mortgage, if that otherwise fits your circumstances.

What's a Hybrid ARM?

Most ARM loans are actually hybrid ARMs, which means the initial interest rate is fixed for a specified number of years. Hybrid ARMs are frequently structured as follows:

  • 3/1 ARMs (3 years fixed, then adjustable yearly)
  • 5/1 ARMs (5 years fixed, then adjustable yearly)
  • 7/1 ARMs (7 years fixed, then adjustable yearly)
  • 10/1 ARMs (10 years fixed, then adjustable yearly)
  • 7/23 loans (7 years fixed, then adjustable once, then again fixed for 23 years)

So Just How Low Are ARM Rates Now?

According to Freddie Mac, the average mortgage rate in January 2005 for 5/1 ARMs was only 0.71% lower than the 30-year fixed rate--and the equivalent ARM in May 2009 was only 0.04% lower than the 30-year fixed rate. However, as of April 29, 2010, 5/1 ARM rates at 4.00%, fully 1.06% lower than 30-year fixed rates at 5.06%.

Thus, a 5/1 ARM may offer you substantial savings if you only expect to be in your home for five years. The monthly payment difference between a 5% fixed and 4% 5/1 ARM for a conforming $417,000 mortgage is $248. Multiply that by 60 months (5 years), and you may save almost $15,000.

Tips for Shopping a Hybrid ARM

As always, get quotes on all hybrid ARMs from several mortgage lenders. Use the respective good-faith estimates (GFEs) to compare loan features, rates, and terms. Be sure you understand the following, in case you do remain in your home past the initial fixed-rate period and choose not to refinance your mortgage loan:

  • Index: The reference or "base" interest rate on which your adjustable interest rate depends (often LIBOR)
  • Margin: The interest rate added to your index to create your adjusted rate
  • Adjustment Cap: The maximum amount by which your interest rate may change in any single adjustment period
  • Lifetime Cap: The maximum interest rate you can ever pay, even after repeated adjustments

Be sure to read and understand your ARM loan terms as summarized on the "rider" before committing yourself. It's important to shop for the lowest mortgage rates, but remember that there are considerations other than finding the lowest rate. The best mortgage lenders will take the time to explain what will happen to your monthly payment under different scenarios and help you understand the benefits as well as the risks.


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