Is Now The Time For Hybrid ARMs?

During May mortgage rates rose significantly, by some measures breaching 4 percent for fixed-rate, 30-year financing. Despite such news it's still possible to get loans with substantially lower mortgage rates.

For example, let's say at this time that borrowers will pay roughly 3.9 percent for a 30-year fixed-rate loan. That's higher than the record-low rates seen late last year but far lower than the charged for mortgage financing during the past several decades.

As an alternative to a 30-year fixed mortgage, borrowers might want to look at -- again roughly and surely subject to change -- 3 percent for a 15-year fixed-rate loan, 2.75 percent for a five-year hybrid ARM, and 2.6 percent for a simple 1-year ARM.

The reason for the low start rate with the simple ARM is that such an interest level may not continue very far into the future. After one year the rate can change, going either up or down. However, even if the rate goes up it's still possible that the interest cost would not rise to the point where we find fixed-rate financing today.

Where rates will go in the future is just conjecture and speculation. No one knows where rates will be at any given time so we can't say if future ARM rates will be higher or lower than today.

This means that with simple ARMs many potential borrowers are leery that rates might go higher in the near future.

Hybrid ARMs

This is where hybrid ARMs come into the picture. Hybrid loans combine some of the features found with fixed-rate mortgages along with some of lower costs found with ARMs.

Perhaps the most important feature with a hybrid ARM is that the start rate stays in place for more than a year, often five years. This means that a borrower can lock-in a low rate for five years after which time the loan becomes a one-year adjustable.

Because the up-front interest level is low with a five-year hybrid ARM, it may be possible for a borrower to get a bigger loan or for marginal borrowers to get financing which would otherwise not be available to them.

Some hybrids have a one-time conversion feature so within a certain period the borrower can convert the loan into a fixed-rate mortgage for the remainder of its life. The new rate is determined at the time of conversion using a formula known in advance. Also, usually, there is a conversion fee.

For the past few years virtually all borrowers have elected fixed-rate financing because rates have been at or near record lows. But now rates -- while are still low by historic standards -- have begun to rise, a reality which is causing some buyers to look at hybrid ARMs, financing with a low start rate and several years of rate stability. In a period of rising rates such a combination can be attractive to a growing number of borrowers.

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