If you are looking for a lower interest rate, but also want a fixed-rate period, you can consider a hybrid loan. These loans start out as fixed-rate mortgages for a limited period of time, and then switch to a variable rate loans after the initial period ends. There are two main types of hybrid loans:
Hybrid fixed/adjustable rate loans: These loans are considered hybrids because, instead of just offering a fixed rate or an adjustable rate, you start out with a fixed rate, but the loan re-sets to an adjustable rate later. The initial interest rate is often low, and sometimes called a “teaser.” Your low fixed rate can last anywhere from one year to 10 years. Once the original period is over, you start paying an adjustable rate.
Hybrid Option ARMs: The hybrid option ARM has a fixed-rate period, and an adjustable-rate period, as well. However, the “option” is manifest by the way the borrower chooses the amortization schedule for a portion of the loan term. The borrower can choose to pay only the interest on the loan for part of the loan, and even choose to pay less than the interest owed. It’s also possible to choose a payment in line with a 15-year or 30-year amortization schedule.
In certain circumstances, hybrid loans can provide advantages for borrowers. For those who want to take advantage of low interest rates, a “regular” hybrid fixed/adjustable rate loan can be helpful. However, it’s important to make sure that you can handle the adjustable payments after the re-set, or refinance to a fixed rate before interest rates rise.
Option ARMs are even riskier when used irresponsibly. While the ability to change payments month to month can be helpful in some cases of irregular cash flow, the fact of the matter is that hybrid option ARMs can be devastating as well. If you don’t make bigger payments on months when you have a higher income, you can add to your principal in months when you choose the negative amortization option. If home values drop, you can’t refinance, and you quickly end up under water.
Hybrid loans should be approached carefully; they are not often the best choice for those who are stretching to afford a home.