Wall Street Journal
Worried that you missed the boat by not refinancing your mortgage before rates started rising?
You might want to consider a hybrid.
Hybrid adjustable rate mortgages — which resemble fixed-rate mortgages in their early years — could be a particularly good deal right now. Take the "five-one" hybrid, which offers a fixed rate for the first five years and then adjusts annually for the next 25 years. Right now, the average rate on a five-one is 6.46 percent, according to HSH Associates, financial publishers in Butler, N.J. That is well below the current 7.33 percent average for 30-year fixed-rate mortgages.
Hybrids allow borrowers "to still get rock-bottom rates," says mortgage banker Doug Perry, a first vice president with Countrywide Homes Loans, a unit of Countrywide Credit Industries Inc. of Calabasas, Calif. "Consumer interest in these products has increased 50 percent to 65 percent in the last couple of weeks."
Because rates can adjust drastically once the fixed term expires, hybrids aren’t for everyone. If interest rates soar, someone with a 6.5 percent hybrid could quickly wind up with an 11.5 percent mortgage and a vastly higher monthly payment. That makes hybrids riskier than standard 15-year and 30-year fixed-rate mortgages and a bad idea for people on tight budgets who are planning to be in their homes for a while.
But hybrids make sense for people who expect to sell their homes or to pay off their mortgage within a few years. A hybrid allows them to get the lower rates of an adjustable-rate mortgage without taking on the higher risks.
"You can essentially have your cake and eat it, too," says Greg McBride, a financial analyst with Bankrate.com.
Hybrids have become a better deal over recent months. That is because rates on 30-year mortgages tend to move in tandem with the rates on 10-year Treasurys, which began climbing in November. Five-one hybrids, on the other hand, generally track one-year Treasurys, which have climbed less.
The bottom line: In December 2000, before the Federal Reserve Board began slashing rates, homeowners could trim their mortgage rate by a mere 0.21 percentage point by choosing a five-one hybrid instead of a 30-year fixed-rate mortgage, according to HSH. Today, the difference is 0.87 percentage point, more than four times more. "That’s very high relative to historical measures," says Steve Majerus, a senior vice president with E-Loan Inc.
The savings can be significant. At today’s 7.33 percent rate, a borrower could expect to pay $1,375 a month on a $200,000 30-year fixed-rate mortgage. But with a five-one hybrid at 6.46 percent, those loan payments would drop to $1,259. Over five years, the hybrid would cut interest charges by nearly $9,000.
Those kinds of benefits were enough to persuade Tim Bradley, a Seattle software developer , to give adjustables a second look. "When we moved into our house, I didn’t want to get one," says Bradley, who was 2.5 years into a 30-year loan when he refinanced his $174,000 mortgage in December. "I worried I would be saddled with a bad interest rate." But after shopping around, Bradley concluded his best bet was an adjustable-rate mortgage that carried a 5.5 percent rate for the first five years. "I’m pretty sure we’re not going to be in our house more than five years," he says.
Homeowners need to pay close attention to the adjustment terms, even if they expect to hold the loan for just a few years. "You’re not supposed to be taking these things if you plan on being there for the long haul," says Keith Gumbinger, a mortgage analyst at HSH.
Rates on hybrids are typically set at between two and three points above a standard measure, such as the rate on one-year Treasurys. Another popular base rate is Libor, the London Interbank Offered Rate, which banks charge each other for short-term funding.
Lenders typically limit the amount the rate can rise both during the first year and over the life of the loan. Bank of America Corp., for instance, sets a five-percentage-point cap on both the first adjustment and the lifetime increase. "If it starts out at 7 percent, then the cap is 12 percent," explains Robert DeBenedet, Bank of America senior vice president.
But the terms can vary by lender, and, in some cases, by product. Countrywide, for example, sets a six-percentage-point lifetime cap on its three-year hybrids, which means a 7 percent loan could wind up carrying a 13 percent rate. But no matter how much rates rise, homeowners will only see their rate go up by as much as two percentage points the first adjustment.
Rates on Countrywide’s five-year hybrids, on the other hand, can increase by as much as two percentage points during the first adjustment period and a maximum of five percentage points over the life of the loan.
Even with the caps, holding a hybrid can be extremely painful if rates rise and borrowers don’t move or pay off their loan as soon as planned.
Talk to us
> Give us your news tips.
> Send us a letter to the editor.
> More Herald contact information.