What is a Hybrid Loan?
A hybrid loan is a mixture of two types of loans—specifically a fixed-rate loan and an adjustable-rate mortgage. The term hybrid in hybrid-loan refers to the fixed period of the loan. Usually, this time is roughly between two and five years.
A hybrid is different than an interest-only loan by applying more money towards the principle of the loan. This results in more cash flow and a higher level of equity.
Related: What Exactly is a Purchase Money Loan
How Hybrid Loans Work
Hybrid loans begin at a lower rate than the standard 30-year fixed-rate mortgage. This offers some protection if the interest rates rise dramatically.
Fixed Period
These hybrid loans utilize a fixed rate for a period of three, five, seven, or ten years. During that time, payments and rates will stay the same. When the loans are listed, the first number will tell you the number of fixed years. For example, a 3/1 hybrid mortgage will hold the same rates for the first three years.
Adjustment Period
Once the fixed period of the loan comes to an end, the interest rate can change. The second number that is listed on the loan terms is how often that will happen for the remainder of the loan term. For example, 3/1 means that the rates can adjust every year for the rest of the loan’s life. After the first three years, that is.
Monthly Payments
Your monthly payment will change as the interest rates change. These loan payments are calculated so that you can pay off your debt and the extra interest charges that may occur over the remaining life of the loan. Higher rates will require higher monthly payments, and lower rates, on the other hand, can drop the monthly payments.
Related: Questions to ask a mortgage lender
When Hybrid Loans Work Best
Lower starting rates are enticing, but they still come with some risk. Hybrid loans make sense under the right circumstances.
Mares Mortgage utilizes a web-based solution that enables you to search rates from over 175 banks.
Short-Timer
If you are planning to refinance or move within a short period, it makes sense to take advantage of the lower rate. That would help you to finish paying off the loan sooner before the adjustments begin. However, if things don’t work out according to plan, you could be paying off the loan for longer than you expected and can incur charges.
Prepayments
There are ways that you can reduce the risks of incurring higher fees. One of the easiest ways is to make additional payments to your hybrid loan. They will help pay down the loan principle quicker to ensure that it’s paid off before the adjustments kick in.
Falling Rates
Predicting the future is hard. While rates can rise, they can also fall. If rates drop lower, that becomes a benefit for the loan holder, but it can also bring the interest rate down lower. An interest cap may be in place, and it is there to protect you from sudden spikes but can prevent you from reaping the benefit of the drops.
Poor Credit
Low rates can help you boost a low credit score during the early years of the hybrid loan. On-time payments will help to improve it, but if later down the road rates change, there is no guarantee that you will requalify for low new rates.
Related: 580 Credit Score Home Loans
How the Rates Change
Two main factors can influence your rate. A lender will begin with an index rate and add a spread. Those factors can also be affected by rate caps. Most hybrid loans have a cap on how much the interest rates can change. The caps on these loans can reduce the risk for borrowers. There are different types of caps so pay attention to what is offered to you.
Initial caps will limit how much your rate is allowed to change on the first adjustment when the fixed period comes to an end. Periodic caps will limit the fluctuation at each adjustment opportunity. Lifetime caps set a maximum on adjustments.
Advantages & Disadvantages of Hybrid Loans
As with any type of loan, there are pros and cons to a Hybrid loan. These types of loans combine fixed and variable plans. Those are both positive and negative when it comes to hybrid-rate loans. Here are some things to keep in mind when making a decision on your loan.
Even Lending Experience
Some financial experts believe that fixed rates and variable rates work well off one another when combined in the hybrid rate. Companies that offer hybrid rate loans will typically promote them as an even lending. This offers the balance of having two parts of the same plan in case you disagree with the first.
Complexity
While, in theory, hybrid-rate loans seem easy, but in practice, they can become more confusing. This might not be a negative to everyone, but if you are looking for a straightforward loan plan, a hybrid-loan may not be for you. They can sometimes seem unpredictable and volatile. If you prefer your finances to be clear-cut, you might find a hybrid-rate plan to be too complex for your taste. Knowing your preferences can help you while looking for the perfect loan.
Fixed-Rate Gamble
This isn’t like playing roulette in Las Vegas, but there are some risks in a fixed-rate plan. While the interest will be frozen, even if the market rate decreases, your interest rate will stay the same. It is impossible to predict the rates at any given time, and that is the gambling part of it.
Get a Better Loan With Mares Mortgage
Getting the best deal on a hybrid loan can be all about timing, but you can get a great deal. These loans can also give you some security in a time where rates change often. Knowing and understanding your options when looking to take out a loan can go a long way with securing your future.
Want to work with a Certified Mortgage Planning Specialist? Mares Mortgage has a membership to the National Association of Mortgage Professions and can help you find the perfect loan for you.
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