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Hybrids Are a Nice Choice, but They're Still ARMs.

Can't decide between a fixed-rate loan and an ARM? Does the 20-year rate thing not do much for you, and you still want a lower payment? Then a hybrid is probably your best choice.

A hybrid, while still an ARM, is so called because it acts like a fixed rate in the first few years, then morphs into an annual ARM. Common hybrids are fixed for three and five years, but hybrids in the seven- to ten-year range can also be found.

Hybrids are listed as 3/1, 5/1, 7/1, and 10/1, indicating both how long the initial rate is fixed for and how often the loan adjusts after that period. A 3/1 ARM is fixed for three years, then turns into a one-year ARM. A 7/1 ARM is fixed for seven years, then becomes an annual ARM.

A 5/6? It's fixed for five years, then turns into a six-month ARM. A 14/4 hybrid? They don't make them, but if you figured it out, then you understand hybrids.

Hybrids are popular because they have a lower starting rate than fixed-rate mortgages but still give some added security in terms of knowing what the rate will be in the future.

Hybrids can also have varying indexes. You might find a lender offering a hybrid based upon a one-year Treasury, another lender with a LIBOR-based hybrid, and still other lenders offering all choices.

And as well as different indexes, there are also different margins. If you're looking at hybrid mortgages, then in reality the margin and index on which your loan is based will be insignificant. By the time the initial fixed period has ended, you've generally either refinanced or sold the property and moved on.

Stay Away from Negative Amortization.

With a name like that, who wouldn't stay away from negative amortization? Heck, I stay away from absolutely everything negative, and you do, too, right?

Negative amortization means that if you don't pay a certain amount each month then money can get added back to your loan balance. Your loan actually grows. It amortizes—negatively. If you make the fully indexed rate payment your loan will not grow. If you make a payment just based on your interest rate with none going toward the principal your loan will not grow. But negative amortization loans also have provisions for you to pay less than interest only, called your "contract" rate.

Think of it this way. You have a five-year car loan with an adjustable rate. You have a balance of $10,000. Your fully indexed payment is $300. But your car lender has been nice to you and has given you a choice of payments: the regular $300 payment, or a lower one of $200.

Who wouldn't choose the $200 payment? Well, you might not if you found out that the $100 difference would be added back to your loan. After 10 months of making only the $200 payment and not the $300 one, another $1,000 has been added to your car loan.

After 10 months, and after making 10 payments, not only haven't you paid your car loan down, but you've actually added to it. Now, is that a good deal? No. It's not a good deal.

Negative-amortization loans, called "neg-am" loans, have been around for a long time. They fall out of favor because they're not good loans, so everyone forgets about them. Later, after everyone has forgotten about them, they rise from the mortgage grave and are given another name, and "voila!": negative amortization. But it can kick people out of their homes.

If neg-am loans are so bad, then why do lenders even offer them? Negative amortization is a feature of some loans that have some fairly attractive features if borrowers understand when they can be used. Neg-am loans aren't bad by nature. They can have a place.

Neg-am is always associated with an adjustable-rate mortgage that offers a variety of loan repayment options. The neg-am feature gives mortgage owners a choice of what to pay each month, usually including the fully indexed rate. The neg-am kicks in when the borrowers decide not to pay the fully indexed rate or interest only, but instead to pay the lower contract rate. Some contract rates can be 1 percent. Or more, or less.

Having the option of paying less can be a benefit for someone who gets paid on an irregular basis, say someone who gets paid when a job is completed, or maybe a business owner whose cash flow increases during holiday seasons, or maybe a commissioned salesperson who gets huge commissions during certain times of the year, but doesn't get much at other times.

The option can also be an advantage for landlords, who might like to pay the fully indexed rate when the rental unit is occupied, but might want to make only the lower payment if and when the unit is vacant.

Such payment choices can be a benefit to borrowers. They are able to pay more when they make a lot of money, then maybe pull back a tad when their cash flow decreases. In other words, a neg-am loan, by itself, is not a bad thing if you know what you're doing.

In the late 2000s, negative-amortization loans vanished. But they've vanished before, and, given their track record over the years, they might soon work their way back into the mortgage lending environment.

 
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