Test Drive a Hybrid Mortgage

Hybrid cars were created to split the difference between performance cars, which can be costly to operate and bad for the environment, and electric vehicles, which can be cumbersome and require very expensive replacement batteries. Today, hybrid autos are more popular than ever and offer some crazy performance.

The new hybrid Porsche 918 Spyder delivers 887 hp, and gets you from 0-62 mph in 2.8 seconds en route to its top speed of 211 mph. The contents of your stomach may take a split second longer to arrive if you're queasy about g-forces.

Hybrid Mortgages from Porsche to Prius

Designers of hybrid mortgages, meanwhile, may be unable to keep pace with those at the Porsche Design Studio, but they too are innovating. Is it time you took a hybrid mortgage for a test drive?

What Is a Hybrid Mortgage?

There are two main categories of mortgages -- fixed rate mortgages (FRMs) and adjustable rate mortgages (ARMs).

As the name implies, FRMs charge the same interest rate throughout the term of your loan. So your first monthly payment is precisely the same as your last -- and (assuming you don't get into arrears or incur penalties) all the others in between.

ARMs are less straightforward: your rate is adjusted at set intervals, and the new rate is determined by movements in financial markets and the specific terms of your loan. ARM interest rates are often tied to the London Interbank Offered Rate (LIBOR) or US Treasuries.

ARMs are defined by the frequency of their adjustments: for example, a one-year ARM can adjust annually, while the rate on a monthly ARM can change each month.

The hybrid ARM combines characteristics of both fixed and adjustable mortgages. The interest rate is fixed for an introductory period, which typically ranges from three to ten years, and then it begins adjusting on a  predetermined schedule.

Hybrid ARMs have names like 3/1, 5/1, 7/1 or 10/1. The first of those numbers describes the period for which the rate is initially fixed (three, five, seven or 10 years), and the second indicates the frequency with which the rate can change, after the fixed period has ended  -- once a year is typical.

Why Doesn't Everyone Choose FRMs?

Clearly FRMs deliver very valuable advantages: they provide security and certainty, and they help make household budgeting simple. So why would anyone choose a hybrid?

Well, they're generally significantly cheaper, at least during that initial period when the rate is fixed. On May 1, 2014, Freddie Mac reported that the average nationwide rate for a 30-year FRM was 4.29 percent. On that same day, that same rate for a 5/1 ARM was 3.05 percent.

So, let's say you're buying a home for $275,000, and have a $75,000 down payment. Your monthly principal and interest payments for a $200,000 FRM at 4.29 percent should be $989 a month.

But the same principal and interest payment for a similar hybrid 5/1 ARM at 3.05 percent would be $849 a month for the first five years. And that $140 a month over 60 months represents a saving of $8,400. You can model your own payments using LendingTree's mortgage calculators.

When Hybrid ARMs Aren't Smart

So FRMs are more expensive. But locking in a rate for 30 years provides a huge amount of security, especially at a time when most economists are forecasting that interest costs are set to rise -- possibly dramatically -- over the next few years.

Truly dramatic increases (and the average rate for 30-year FRMs touched 18.45 percent in 1981, according to Freddie Mac) shouldn't bother ARM borrowers too much, because most such loan agreements provide:

  1. An initial adjustment cap, which limits the rate rise that can be imposed when the fixed-rate period ends. This is typically two or three percent for fixed-rate periods of five years or less, but may be as much as five percent for 7/1 and 10/1 loans.
  2. A periodic adjustment cap, which limits -- often at two percent -- the possible rises whenever the rate's reviewed, usually each year.
  3. A lifetime cap, which sets a maximum rate for the life of the loan. This is generally five or six percent over the loan's initial rate.

Increases in monthly payments could still be significant, once the initial fixed rate expires. If you plan to live in your home for a long time, and can afford the cost of a 30-year FRM, you might well be glad in five or 10 years' time you paid the higher initial rate.

When Hybrid ARMs Are Smart

In reality, not that many Americans live in their homes for a long time.  Indeed, in 2011-12, 12 percent of people in this country over the age of one moved at least once, according to the U.S. Census Bureau. That means, as a nation, we each change homes every 8.3 years on average. Sometimes, paying extra to lock in a rate for three decades makes little sense.

Not locking in rates may involve a gamble, but some people are in a stronger position to place that bet than others. If you're pretty sure you're going to have to move in the next five, seven or 10 years -- because your family's going to grow or shrink, or your career's going to take you to a new city, or your earnings are going to rise or fall so that you're going to want a grander or more modest home -- then such a wager could be worthwhile.

A lesser bet might tempt those who simply can't afford the payments on a 30-year FRM. Should you wait, and risk both interest rates and home prices rising, so making your dream of home ownership even less attainable? Or should you go for a hybrid ARM, and hope you're going to be able to meet the higher payments that may arise when your initial fixed rate expires? Only you can decide.

Hybrid Innovations

More recent types of hybrid mortgage have included 3/3 ARMs and 5/5 ARMs. The latter provides a fixed rate for an initial five-year period, and then allows rate adjustments only once every five years. This provides a much higher degree of certainty and security than annual rate adjustments do, and it's no surprise these are growing more popular.

The reality is, certainty and security are valuable commodities, so consumers inevitably pay for them. And the more you want, the higher the cost. You have to decide on the risk with which you're comfortable, and your options run from a 30-year FRM all the way to a 1/1 ARM.

Or you could just forget the whole thing and instead buy a hybrid Porsche 918 Spyder. Sadly, however, auto loans tend to be less flexible than mortgages.

Get Home Mortgage Loan offers customized for you today.