Q: I have advised my kids not to get any kind of mortgages but fixed rate loans with full amortization. My youngest is ready to buy her first home on a very slim budget and was told that she could get a lower payment with a 5/1 hybrid ARM. I don't like the sound of that, but before I argue with her I should probably learn how it works.
A: A hybrid adjustable rate mortgage (ARM) has an introductory period during which its rate is fixed. When this period expires, the loan converts to an adjustable rate mortgage. In the case of a 5/1 hybrid ARM, the interest rate is fixed for the first five years; then it converts to an ARM with annual rate adjustments for the life of the loan.
The name of the loan tells you how it's structured -- for example, a 3/1 ARM is fixed for three years and then adjusts once a year. A 3/3 ARM is fixed for three years and then adjusts every three years. ARMs typically carry lower mortgage rates than fixed loans and can help homebuyers lower their monthly payments for a few years. A hybrid ARM can be a good choice, especially if your daughter is planning to relocate or refinance within the five-year fixed rate period.
Hybrid ARMs can be reasonably safe because the amount the rate can be raised at any adjustment is capped, as is the rate the loan can hit during its lifetime. Typically, a loan that starts at a three percent rate can't go higher than nine percent in its lifetime.
To get the best hybrid ARM, get several mortgage quotes from competing lenders and compare terms -- start rate, index, margin, and caps -- to find the loan that will perform best during the time she expects to own the home.