4. Are you shopping for a mortgage to finance a home that you expect to own for

Question

4. Are you shopping for a mortgage to finance a home that you expect to own for no more than a few years? If so, you should know about a hybrid mortgage. Hybrid loans give prospective home buyers the ability to buy a lot more home than they can afford-thanks to the initially lower interest rate. But with such flexibility comes greater risk. Since lenders are free to design loans to fit borrowers' needs, the terms and fees vary widely and home owners can get bumed if rates elimb higher Hybrid mortgages allow homeowners to benefit from the best aspects of both fixed-rate and adjustable-rate mortgages (ARMs). With hybrids, borrowers choose to accept a fixed interest rate over a number of years-usually, 3, 5, 7, or 10 years-and afterward the loan converts to an ARM. But therein lies the danger: While you're getting an extraordinarily low rate up front for a few years, when the fixed-rate period expires you could very well end up paying more than double your current rate of interest. At a rate of 616% for a 30-year mortgage, for example, a person borrowing $200,000 would pay si 220 a month with a seven-year hybrid more commonly called a 7/1 loan at the going rate of 5.61%, that monthly payment drops to $1,150. By the end of the seventh year, the homeowner would save about $7,700 in interest charges by going with a seven-year hybrid. To say that there are drawbacks is an understatement. Despite the surge in populurity, a hybrid loan can be ticking time bomb for borrowers who plan on holding the loan for the long term. Discuss the potential drawbacks associated with the hybrid ARMs by giving a specific loan and interest rale scenario.

Explanation / Answer

I. First Adjustment Can Be Large

The first adjustment to happen in an economy where interest rates have been rising. Interest rates have raised several points over the last few years, and periodic caps don’t apply to the initial change. This could mean a big and sudden increase in monthly payment.

II. Rates Rise over the years

While periodic caps can help moderate big increases to your rate and mortgage payment, lifetime caps are usually can rise. IARM that starts out at 4% can climb to 9% or 10% over the life of the loan.

III. Your Best Laid Plans May Hit a Snag

There is more risk involved for the borrower with ARMs, which is one of the reasons the introductory rates are so attractive. Getting a mortgage with an ARM requires careful planning for when and how you’ll sell or refinance, or how you’ll manage higher payments if you don’t sell. But things don’t always go according to plan, which could mean you have trouble selling or refinancing when you need to.

IV. Negative Amortization

Because of the complexity of some kinds of ARMs, it’s possible to end up owing more money than you did at closing. This is possible due to negative amortization loans, where payments are so low that they only cover a part of the interest due. The remaining interest gets rolled into the principal balance, which could grow over time.

V. Prepayment Penalty

Because many borrowers will sell or refinance before an ARM’s initial adjustment, some ARM loans come with a prepayment penalty. This penalty may apply if you sell or refinance within the fixed-rate period. In some cases, the benefit of a low rate may outweigh the cost of the penalty. In others, you may want to ask your lender for an ARM without a penalty.

VI. Complex

For a first-time buyer, the ins and outs of a fixed-rate mortgage can be complicated. ARMs are even more complex. The terms, rules, fees, and structures of ARMs can be difficult to understand. Of course, there may be a way to work within these rules to your benefit. Speaking to a licensed loan officer, in detail, about your needs and options is a must.

Mortgage Loan Amount: $175,000.00 Mortgage Term: 30 years Beginning Interest Rate: 6.160% Beginning Monthly P&I Payment: $1,067.28 Taxes & Other Monthly Expenses: $0.00 Total Initial Monthly Payments: $1,067.28 Maximum Monthly P&I Payment: $1,554.11 Taxes & Other Monthly Expenses: $0.00 Total Maximum Monthly Payments: $1,554.11 Maximum Interest Rate: 11.160% Expected Initial Rate Adjustment: 2.00% Expected Further Rate Adjustments: 0.50% Initial Fixed Rate Period: 84 Months Adjustment Period: 12 Months Total of All P&I Monthly Payments: $506,600.17 Total Interest: $331,600.17 Average Monthly Payments: $1,407.22

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