What is a hybrid ARM?

Mixing features of both fixed-rate and adjustable-rate mortgages, a hybrid adjustable-rate mortgage (or “fixed-period ARM”) combines the best of both worlds. An adjustable-rate term will follow the fixed-rate period in this mortgage type. Interest rates are subject to index plus margin adjustments once the fixed rate period ends. The “reset date” is when the mortgage’s interest rate goes from fixed to adjustable.

A 5/1 hybrid ARM typically has a fixed term of 5 years and adjustable rates that reset every 12 months. This is the most popular design.

The Importance of Hybrid Arms

When selecting a hybrid arm, a borrower should think long and hard about how long it will be before the reset date, or the end of the fixed interest rate term, rolls around. Depending on the magnitude of the interest rate change, this reset might result in very high payments; however, in most cases, there is a limit to how much the rate can change.

There are other adjustable-rate mortgage options than the 5/1 hybrid ARM, which is the most common. Also, you may find ARMs with terms of 3/1, 7/1, and 10/1. After an initial fixed-rate period of three, seven, or ten years, the interest on these loans will change once a year.

A 5/5 ARM has an introduction term of five years and subsequent rate adjustments every five years, whereas a 5/6 ARM has adjustments every six months. Specifically, after 15 years, 15/15 ARMs undergo one adjustment. Both the 2/28 and 3/27 ARMs are rare. 3 The former has a set rate for just the first two years, then the rates are adjustable for the remaining twenty-eight; the latter has a fixed rate for just three years, and then modifications occur once every twenty-seven. Rather than adjusting once a year, some of these loans adjust every six months.

The Construction of Hybrid ARM

A hybrid adjustable-rate mortgage can have a fixed rate for 3, 5, 7, or 10 years and then have the adjustable rate reset at that point. It is standard practice to evaluate and recalculate the mortgage interest rate once a year after the reset date has passed.

Although hybrid adjustable-rate mortgages (ARMs) provide homeowners with alternatives that may better suit their requirements, long-term fixed-rate mortgages—particularly those with 30 years—can experience competitively low-interest rates. For example, because most homeowners don’t plan to stay in their homes for 30 years, applying for a mortgage with interest rates that are more appropriate for the time they anticipate holding the property could be more appealing.

To determine the new rate implemented after the reset date, a hybrid adjustable-rate mortgage (ARM) uses an index as the benchmark interest and adds the margin. The index’s foundation might be several standards, including the London Interbank Offered Rate.

The floor is the lowest possible interest rate the loan’s adjustable-rate term may reach. The interest rate, for instance, may be subject to the lender’s specified margin.

Lenders may use an index that is part of the lookback period to determine the new adjustable rate when the reset date rolls around. Depending on the lender, this duration may be anywhere from 45 days to a year.

Conclusion

• The interest rate on a hybrid adjustable-rate mortgage (ARM) changes yearly after an initial fixed-rate period ends.
• Once hybrid ARMs are variable, they will typically make adjustments once a year.
• During the fixed term, homeowners often pay less on their mortgages. However, once the fixed period ends, they may lose out if interest rates increase.
• The 5/1 hybrid adjustable-rate mortgage (ARM) is the most common; it begins with a fixed 5-year term and then adjusts annually at a variable rate.