A hybrid adjustable rate mortgage (ARM) combines the benefits of a fixed rate mortgage and a traditional adjustable rate mortgage. With a hybrid ARM, part of the interest rate is fixed for an introductory period (typically three, five, seven or ten years). Then, after the initial period, the interest rate can increase or decrease based on current market conditions.
For example, with a hybrid ARM a borrower might have a 5/1 ARM. The 5 refers to the number of years the interest rate is fixed, and the 1 refers to how often the rate can adjust after the fixed period. With this type of ARM, you would have a fixed rate for the first 5 years and then it can adjust every year after that.
Benefits of a Hybrid ARM
The main benefit of a hybrid ARM is the lower interest rate compared with a fixed-rate mortgage. This can allow you to get more for your money, as you are paying less in interest over the life of the loan. Additionally, while the interest rate is fixed during the introductory period of the loan, you will benefit from the protection of not having your interest rate increase during that period.
Another advantage of a hybrid ARM is that, after the fixed period ends, you will be in a better position to capitalize on lower interest rates should market rates move down. On the other hand, if rates increase, you can usually limit your exposure to the cap established by the lender before the loan is originated.
Drawbacks of a Hybrid ARM
The main disadvantage of a hybrid ARM is the risk of interest rate increases that comes with any adjustable rate loan. If the interest rate were to go up after the introductory fixed period, your monthly mortgage payments could become unaffordable. Additionally, you generally cannot refinance with a hybrid ARM if you have little to no equity in your home.
For these reasons, a hybrid ARM may not be the best option for people who plan to stay in their home for a long time or are looking for the security of a fixed rate mortgage. If you are willing to assume the risk of higher mortgage payments down the road, a hybrid ARM may be a good fit for you.