Posts Tagged ‘AdjustableRate’

5/1 Hybrid Adjustable-Rate Mortgage (5/1 Hybrid ARM) Examples

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What Is a 5/1 Hybrid Adjustable-Rate Mortgage (5/1 ARM)?

A 5/1 hybrid adjustable-rate mortgage (5/1 ARM) begins with an initial five-year fixed interest rate period, followed by a rate that adjusts on an annual basis. The “5” in the term refers to the number of years with a fixed rate, and the “1” refers to how often the rate adjusts after that (once per year). As such, monthly payments can go up—sometimes dramatically—after five years.

Key Takeaways

  • 5/1 hybrid adjustable-rate mortgages (ARMs) offer an introductory fixed rate for five years, after which the interest rate adjusts annually.
  • When ARMs adjust, interest rates change based on their marginal rates and the indexes to which they’re tied.
  • Homeowners generally enjoy lower mortgage payments during the introductory period.
  • A fixed-rate mortgage may be preferable for homeowners who prefer predictability with their mortgage payments and interest costs.

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How a Hybrid Adjustable-Rate Mortgage (Such as a 5/1 Hybrid ARM) Works

The 5/1 hybrid ARM may be the most popular type of adjustable-rate mortgage, but it’s not the only option. There are 3/1, 7/1, and 10/1 ARMs as well. These loans offer an introductory fixed rate for three, seven, or 10 years, respectively, after which they adjust annually.

Also known as a five-year fixed-period ARM or a five-year ARM, this mortgage features an interest rate that adjusts according to an index plus a margin. Hybrid ARMs are very popular with consumers, as they may feature an initial interest rate significantly lower than a traditional fixed-rate mortgage. Most lenders offer at least one version of such hybrid ARMs; of these loans, the 5/1 hybrid ARM is especially popular.

Other ARM structures exist, such as the 5/5 and 5/6 ARMs, which also feature a five-year introductory period followed by a rate adjustment every five years or every six months, respectively. Notably, 15/15 ARMs adjust once after 15 years and then remain fixed for the remainder of the loan. Less common are 2/28 and 3/27 ARMs. With the former, the fixed interest rate applies for only the first two years, followed by 28 years of adjustable rates; with the latter, the fixed rate is for three years, with adjustments in each of the following 27 years. Some of these loans adjust every six months rather than annually.

Hybrid ARMs have a fixed interest rate for a set period of years, followed by an extended period during which rates are adjustable.

Example of a 5/1 Hybrid ARM

Interest rates change based on their marginal rates when ARMs adjust along with the indexes to which they’re tied. If a 5/1 hybrid ARM has a 3% margin and the index is 3%, then it adjusts to 6%.

But the extent to which the fully indexed interest rate on a 5/1 hybrid ARM can adjust is often limited by an interest rate cap structure. The fully indexed interest rate can be tied to several different indexes, and while this number varies, the margin is fixed for the life of the loan.

A borrower can save a significant sum on their monthly payments with a 5/1 hybrid ARM. Assuming a home purchase price of $300,000 with a 20% down payment ($60,000), a borrower with very good/excellent credit can save 50 to 150 basis points on a loan and more than $100 per month in payments on their $240,000 loan. Of course, that rate could rise, so borrowers should anticipate a rise in their monthly payment, be prepared to sell their home when their rate goes up, or be ready to refinance.

Note

When refinancing from an ARM to a fixed-rate mortgage, it’s important to consider the new loan term carefully, as it could have a significant impact on how much you pay in total interest to own the home.

Advantages and Disadvantages of a 5/1 Hybrid ARM

In most cases, ARMs offer lower introductory rates than traditional mortgages with fixed interest rates. These loans can be ideal for buyers who plan to live in their homes for only a short period of time and sell before the end of the introductory period. The 5/1 hybrid ARM also works well for buyers who plan to refinance before the introductory rate expires. That said, hybrid ARMs like the 5/1 tend to have a higher interest rate than standard ARMs.

Pros

  • Lower introductory rates than traditional fixed-interest mortgages

  • Interest rates possibly drop before the mortgage adjusts, resulting in lower payments

  • Good for buyers who will live in their homes for short periods of time

Cons

  • Higher interest rates than standard adjustable-rate mortgages (ARMs)

  • When mortgage adjusts, interest rates probably rise

  • Could be trapped in unaffordable rate hikes due to personal issues or market forces

There’s also a chance that the interest rate might decrease, lowering the borrower’s monthly payments when it adjusts. But in many cases, the rate will rise, increasing the borrower’s monthly payments.

If a borrower takes out an ARM with the intention of getting out of the mortgage by selling or refinancing before the rate resets, then personal finances or market forces might trap them in the loan, potentially subjecting them to a rate hike that they can’t afford. Consumers considering an ARM should educate themselves on how they work.

5/1 Hybrid ARM vs. Fixed-Rate Mortgage

A 5/1 hybrid ARM may be a good mortgage option for some homebuyers. But for others, a fixed-rate mortgage may be more appropriate. A fixed-rate mortgage has one set interest rate for the life of the loan. The rate is not tied to an underlying benchmark or index rate and doesn’t change; the interest rate charged on the first payment is the same interest that applies to the final payment.

A fixed-rate mortgage could yield advantages for a certain type of homebuyer. If you’re interested in predictability and stability with mortgage rates, for example, then you might lean toward a fixed-rate loan instead of a 5/1 hybrid ARM. Comparing them side by side can make it easier to decide on a mortgage option.

5/1 Hybrid ARM vs. Fixed-Rate Mortgage
5/1 Hybrid ARM Fixed-Rate Mortgage
The loan’s interest rate adjusts after the initial fixed-rate period. The interest rate remains the same for the life of the loan.
Monthly payments could increase or decrease as the rate adjusts. Monthly payments are predictable and do not fluctuate due to changing rates.
More difficult to estimate the total cost of borrowing as rates adjust. Homebuyers can estimate their total cost of borrowing over the life of the loan.

Is a 5/1 Hybrid ARM a Good Idea?

A 5/1 hybrid ARM could be a good choice for homebuyers who don’t plan to stay in the home long term or who are confident in their ability to refinance to a new loan before the rate adjusts. If interest rates remain low and adjustments to the index rate are relatively minor, then a 5/1 hybrid ARM could save you more money over time compared to a fixed-rate mortgage.

But it’s important to consider how feasible refinancing is and where interest rates might be when you’re ready to move to a new loan. If interest rates rise, then refinancing to a new fixed-rate loan or even to a new ARM may not yield that much in interest savings.

If you don’t plan to refinance and don’t plan to move, then it’s important to consider how realistic that might be for your budget if a rate adjustment substantially increases your monthly payment. If the payment becomes too much for your budget to handle, you may be forced into a situation where you have to sell the property or refinance. And in a worst-case scenario, you could end up facing foreclosure if you default on the loan payments.

If you’re interested in refinancing from a 5/1 hybrid ARM to a fixed-rate mortgage, consider the interest rates for which you’re likely to qualify, based on your credit history and income, to determine if it’s worthwhile.

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5/6 Hybrid Adjustable-Rate Mortgage (5/6 Hybrid ARM)

Written by admin. Posted in #, Financial Terms Dictionary

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A 5/6 hybrid adjustable-rate mortgage (5/6 hybrid ARM) is an adjustable-rate mortgage (ARM) that has a fixed interest rate for the first five years, after which the interest rate can change every six months.

Key Takeaways

  • A 5/6 hybrid adjustable-rate mortgage (5/6 hybrid ARM) is a mortgage with an interest rate that is fixed for the first five years, then adjusts every six months after that.
  • The adjustable interest rate on 5/6 hybrid ARMs is usually tied to a common benchmark index.
  • The biggest risk associated with a 5/6 hybrid ARM is that the adjustable interest rate will rise to a level that makes the monthly payments unaffordable.

How a 5/6 Hybrid ARM Works

As the name indicates, a 5/6 hybrid ARM combines the characteristics of a traditional fixed-rate mortgage with those of an adjustable-rate mortgage. It starts out with a fixed interest rate for five years. Then the interest rate becomes adjustable for the remaining years of the mortgage.

The adjustable rate is based on a benchmark index, such as the prime rate. On top of that, the lender will add additional percentage points, known as a margin. For example, if the index is currently at 4% and the lender’s margin is 3%, then your fully indexed interest rate (the rate that you would actually pay) will be 7%. While the index is variable, the margin is fixed for the life of the loan.

A 5/6 hybrid ARM should have caps on how much the interest rate can rise in any given six-month period, as well as over the life of the loan. This offers some protection against rising interest rates that could make the monthly mortgage payments unmanageable.

Tip

If you’re shopping for a 5/6 hybrid ARM, or for any other type of ARM, you may be able to negotiate with the lender for a lower margin.

How Are 5/6 Mortgages Indexed?

Lenders can use different indexes to set the interest rates on their 5/6 hybrid ARMs. Two commonly used indexes today are the U.S. prime rate and the Constant Maturity Treasury (CMT) rate. The London Interbank Offered Rate (LIBOR) index was once in wide use as well, but it is now being phased out.

While interest rates can be hard to predict, it’s worth noting that in a rising-interest-rate environment, the longer the time period between interest rate reset dates, the better it will be for the borrower. For example, a 5/1 hybrid ARM, which has a fixed five-year period and then adjusts on an annual basis, would be better than a 5/6 ARM because its interest rate would not rise as quickly. The opposite would be true in a falling-interest-rate environment.

5/6 Hybrid ARM vs. Fixed-Rate Mortgage

Whether an adjustable-rate mortgage or a fixed-rate mortgage would be better for your purposes depends on a variety of factors. Here are the major pros and cons to consider.

Advantages of a 5/6 Hybrid ARM

Many adjustable-rate mortgages, including 5/6 hybrid ARMs, start out with lower interest rates than fixed-rate mortgages. This could provide the borrower with a significant savings advantage, especially if they expect to sell the home or refinance their mortgage before the fixed-rate period of the ARM ends.

Consider a newly married couple purchasing their first home. They know from the outset that the house will be too small once they have children, so they sign up for a 5/6 hybrid ARM and take advantage of the lower interest rate until they’re ready to trade up to a larger home.

However, the couple should be careful to check the 5/6 hybrid ARM contract before signing it, to make sure that it doesn’t impose any costly prepayment penalties for getting out of the mortgage early.

Disadvantages of a 5/6 Hybrid ARM

The biggest danger associated with a 5/6 hybrid ARM is interest rate risk. Because the interest rate can increase every six months after the first five years, the monthly mortgage payments could rise significantly and even become unaffordable if the borrower keeps the mortgage for that long. With a fixed-rate mortgage, by contrast, the interest rate will never rise, regardless of what’s going on in the economy.

Of course, the interest rate risk is mitigated to some degree if the 5/6 hybrid ARM has periodic and lifetime caps on any interest rate rises. Even so, anyone considering a 5/6 hybrid ARM would be wise to calculate what their new monthly payments would be if the rates were to rise to their caps and then decide whether they could manage the added cost.

Is a 5/6 Hybrid ARM a Good Idea?

Whether a 5/6 hybrid ARM is right for you could depend on how long you plan to keep it. If you expect to sell or refinance the home before the five-year fixed-rate period expires, you’ll benefit from its generally low fixed interest rate.

However, if you plan to keep the loan past the five-year mark, you may do better with a traditional fixed-rate mortgage. Your payments may be somewhat higher initially, but you won’t face the risk of them increasing dramatically when the 5/6 hybrid ARM begins to adjust.

Bear in mind that there are many different types of mortgages to choose from, both fixed-rate and adjustable-rate.

FAQs

What is a 5/6 hybrid adjustable-rate mortgage (5/6 hybrid ARM)?

A 5/6 hybrid adjustable-rate mortgage (5/6 hybrid ARM) has a fixed interest rate for the first five years. After that, the interest rate can change every six months.

How is the interest rate on a 5/6 hybrid ARM determined?

The lender will set the five-year fixed rate based on your creditworthiness and the prevailing interest rates at the time. When the adjustable rate kicks in after five years, it will be based on a benchmark index, such as the prime rate, plus an additional percentage tacked on by the lender, known as the margin.

Are there any protections with a 5/6 hybrid ARM to keep the interest rate from rising too high?

Many 5/6 hybrid ARMs and other types of ARMs have caps that limit how much they can rise in any given time period and in total over the life of the loan. If you are considering an ARM, be sure to find out whether it has these caps and exactly how high your interest rate could go.

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2/28 Adjustable-Rate Mortgage (2/28 ARM)

Written by admin. Posted in #, Financial Terms Dictionary

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Homebuyers face may choices in types of mortgages, from longer-term fixed rate loans to shorter-term adjustable-rate loans. A 2/28 adjustable-rate mortgage is one type of adjustable rate mortgage that is less common than the traditional 30-year fixed mortgage, but it may suit some buyers’ needs.

A 2/28 mortgage essentially offers a two-year fixed interest rate followed by a floating rate for 28 years. Learn how this type of mortgage works, and more about the pros and cons.

What Is a 2/28 Adjustable-Rate Mortgage (2/28 ARM)?

A 2/28 adjustable-rate mortgage (2/28 ARM) is a type of 30-year home loan that has an initial two-year fixed interest rate period. After this two-year period, the rate floats based on an index rate plus a margin.

The initial teaser rate is typically below the average rate of conventional mortgages, but the adjustable rate can then rise significantly. Since banks don’t make much money on the initial teaser rate, 2/28 ARMs include hefty prepayment penalties during the first two years.

Key Takeaways

  • 2/28 adjustable-rate mortgages (ARMs) offer an introductory fixed rate for two years, after which the interest rate adjusts semiannually for 28 more years.
  • When ARMs adjust, interest rates change based on their marginal rates and the indexes to which they’re tied.
  • Homeowners generally have lower mortgage payments during the introductory period, but are subject to interest rate risk afterward.

Understanding 2/28 Adjustable-Rate Mortgages (2/28 ARMs)

The 2/28 ARMs became popular during the real estate boom of the early 2000s, when soaring prices put conventional mortgage payments out of reach for many buyers.

Other ARM structures exist, such as 5/1, 5/5, and 5/6 ARMs, which feature a five-year introductory period followed by a rate adjustment every five years or every six months, respectively. Notably, 15/15 ARMs adjust once after 15 years and then remain fixed for the remainder of the loan.

Less common are the 2/28 and 3/27 ARMs. With the former, the fixed interest rate applies for only the first two years, followed by 28 years of adjustable rates. With the latter, the fixed rate is for three years, with adjustments in each of the following 27 years. In these cases, rates adjust semiannually.

Example of 2/28 ARM

For example, let’s say you are buying a $350,000 home and providing a down payment of $50,000. You have a $300,000 2/28 ARM mortgage with an initial interest rate of 5% and monthly payments of $1,906. (Total monthly mortgage payments vary when property taxes and insurance costs are factored in. This example assumes $230 per month in property tax and $66 per month in insurance costs.)

With a 2/28 ARM, your interest rate of 5% remains fixed for two years. Then, it can change based on changes in a broader index rate. Let’s say your interest rate then rises to 5.3%. Your total monthly costs would rise to $1,961. Your interest rate would continue to change over the remainder of the loan depending on the broader index. So, the total costs of the loan would be difficult to estimate.

In comparison, if you had a 30-fixed mortgage on the same loan with 5% interest, you would pay $1,906 per month and you can expect to pay $279,987 in total interest if you did not pay the loan off early.

Risks of 2/28 ARMs

The risk with an adjustable-rate mortgages like an 2/28 ARM is the potential for the rate to increase. After two years, the rate is adjusted every six months, typically upward, by a margin above an index rate, such as the federal funds rate or the Secured Overnight Financing Rate (SOFR). 2/28 ARMs have some built-in safety features, such as a lifetime interest rate cap and limits on how much the rate can change with each period. But even with caps, homeowners can face significant payment spikes in volatile markets.

During the boom, many homeowners failed to understand how a seemingly small rate increase could dramatically boost their monthly payment. And even many of those who were fully aware of the risks viewed 2/28 ARMs as a short-term financing vehicle. The idea was to take advantage of the low teaser rate, then refinance after two years to either a conventional mortgage. Or, if their credit was not good enough, they would refinance to a new adjustable mortgage. Amid spiking real estate prices, this strategy kicked the debt further down the road. To many, this made a certain amount of sense since, after all, the borrower’s home equity was rising fast.

But with the market collapse in 2008, home values plummeted. Many owners with 2/28 ARMs found were unable to refinance, make their payments, or sell their homes for the value of the outstanding loan. The rash of foreclosures led to stricter loan standards. Today, banks more carefully evaluate a borrower’s ability to make adjustable-rate payments.

2/28 ARM vs. Fixed Rate Mortgage

Adjustable-rate mortgages like a 2/28 ARM work differently than fixed-rate mortgages and this difference is important to understand for planning your long-term finances.

An adjustable rate mortgage will have an interest rate that can change. That means your monthly payments can change and the overall total interest you will pay is unpredictable. Because the interest can change, you will need to prepare for the possibility that you will have to make higher monthly payments.

In contrast, interest on a fixed-rate mortgage does not change. You can plan for the same monthly payment for the life of the loan. A 2/28 ARM offers the fixed rate for only the first two years, after which the rate can adjust.

Is a 2/28 Adjustable-Rate Mortgage Right for You?

A 2/28 adjustable-rate mortgage has advantages and disadvantages that make it ideal for some buyers but not for others. Weigh the pros and cons with your own financial situation to determine if this type of mortgage is right for you.

You may benefit from a 2/28 ARM if you need a lower monthly payment at the beginning of your mortgage and if you believe you will be able to make higher monthly payments in the future. However if you can afford a higher monthly payment, you may save more money in total interest costs with other loan options, such as a 15-year fixed-rate loan.

What are the Disadvantages of an Adjustable-Rate Mortgage?

An adjustable-rate mortgage can provide lower monthly payments at the beginning of the loan, but borrowers need to prepare for the potential that their payments can increase. If the interest rate increases, then monthly costs and total borrowing costs increase.

What is a 5/1 ARM with a 30-year Term?

With a 5/1 adjustable-rate mortgage (ARM), your interest rate is fixed, or remains the same, for the first five years. Then, it adjusts once a year. When these mortgages have a 30-year term, that means you will have a fixed interest rate for five years and an adjustable rate for the next 25 years. These loans are also known as 5/1 hybrid adjustable-rate mortgages.

Can You Pay off an ARM Loan Early?

Whether you can pay off an adjustable-rate mortgage (ARM) early depends on the terms of your loan. With some ARMs, you may face a prepayment penalty if you pay the loan off early, including if you sell the home or refinance the loan.

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3/27 Adjustable-Rate Mortgage (ARM)

Written by admin. Posted in #, Financial Terms Dictionary

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A 3/27 adjustable-rate mortgage (ARM) is a 30-year loan that carries a fixed interest rate for the first three years, then a variable rate for the remaining 27 years. Borrowers often use a 3/27 ARM as a short-term financing vehicle that they can later refinance into a mortgage with more favorable terms.

Key Takeaways

  • A 3/27 adjustable-rate mortgage (ARM) is a 30-year mortgage with a three-year fixed interest rate period.
  • The fixed interest rate is generally lower than the current rates on 30-year conventional mortgages.
  • After three years, and for the remaining 27 years of the loan, the interest rate will float based on an index, such as the yield on one-year U.S. Treasury bills.
  • Because their monthly payments can rise significantly once the interest rate adjusts, borrowers should plan carefully before taking out a 3/27 ARM to make sure it will still be affordable.

How a 3/27 ARM Works

Adjustable-rate mortgages (ARMs) are a type of home loan in which the interest rate applied to the outstanding balance varies throughout the life of the loan. With an ARM, the initial interest rate is fixed for a period of time. After that, the rate resets periodically, at yearly, semiannual, or even monthly intervals.

ARMs differ from fixed-rate mortgages, the other primary mortgage type, which charge a set rate of interest that remains the same for the entirety of the loan.

3/27 ARMs are a kind of hybrid. For the first three years, they have a fixed interest rate, which is generally lower than the current rates on 30-year conventional mortgages. But after that, and for the remaining 27 years of the loan, their interest rate will fluctuate based on a benchmark index, such as the yield on one-year U.S. Treasury bills.

The lender also adds a margin on top of the index to set the interest rate that the borrower will actually pay. The total is known as the fully indexed interest rate. This rate is often substantially higher than the initial three-year fixed interest rate, although 3/27 ARMs usually have caps on how quickly they can increase.

Typically, the interest rate on a 3/27 ARM won’t increase more than 2% per adjustment period, which can occur every six or 12 months. That means the rate can increase by two full percentage points (not 2% of the current interest rate). So, for example, the rate might go from 4% to 6% in a single adjustment period.

There might also be a life-of-the-loan cap set at 5% or more. In that case, the interest rate on a mortgage that started at 4% might go no higher than 9%, regardless of what happens with the index on which it is based.

3/27 ARM Example

Say a borrower takes out a $250,000 3/27 ARM at an initial fixed rate of 3.5%. For the first three years, their monthly mortgage payment will be $1,123.

Then let’s assume that after three years, the benchmark interest rate is 3% and the bank’s margin is 2.5%. That adds up to a fully indexed rate of 5.5%.

If the borrower still has the 3/27 ARM and hasn’t refinanced into a different mortgage, their monthly payment will now be $1,483, an increase of $360.

To avoid payment shock when the interest rate begins to adjust, borrowers with 3/27 ARMs should aim to refinance the mortgage within the first three years.

Risks of a 3/27 ARM

The most serious risks for borrowers with a 3/27 mortgage are that they won’t be able to refinance their loan before the adjustable rate kicks in and that interest rates will have shot up in the meantime. That could happen if their credit score is too low, if their home has fallen in value, or simply if market forces have caused interest rates to rise across the board.

In that event, they would be stuck with the adjustable rate, which could mean considerably higher monthly payments, as in the example above.

ARM Prepayment Penalties

Borrowers should also be aware that ARMs, including 3/27 mortgages, may carry prepayment penalties, which can make refinancing costly and defeat the purpose of taking out an ARM with the intention of switching to a different loan in a few years.

The Consumer Financial Protection Bureau (CFPB) suggests that borrowers check the lender’s Truth in Lending Act disclosure for any prepayment penalties before they sign a contract.

“Remember, many aspects of the loan are negotiable,” the CFPB notes. “Ask for a loan that does not have a prepayment penalty if that is important to you. If you don’t like the terms of a loan and the lender won’t negotiate, you can always shop around for a different lender with terms that better suit your needs.”

Is a 3/27 ARM a Good Investment?

A 3/27 ARM could be a good choice for you if you’re looking for a loan with relatively low monthly payments for the first several years. That could make buying a home more affordable if your budget is already stretched or could give you some extra cash to spend on home repairs, furnishings, or other purposes, compared with a more expensive loan.

However, you’ll want to be reasonably certain that you’ll be in a good position to refinance by the end of the initial three-year period. That means, for example, that you’ll have a strong credit score and a reliable source of income at that point.

A 3/27 ARM is not a good idea if there’s a strong possibility that you won’t be able to refinance (or sell the home) during those first three years and the new, adjustable-rate payments would be too much for you.

FAQs

What is a 3/27 adjustable-rate mortgage (ARM)?

A 3/27 adjustable-rate mortgage (ARM) charges a fixed interest rate for the first three years, followed by a variable interest rate for the remaining 27 years. Because it combines the features of a fixed-rate mortgage and an adjustable-rate mortgage, it is sometimes referred to as a hybrid ARM.

What are the advantages of a 3/27 ARM?

A 3/27 ARM is likely to have a low interest rate for the first three years. But that rate can rise substantially starting in the fourth year.

Is a 3/27 ARM right for me?

If you plan to sell the home or refinance it within the first three years, then a 3/27 ARM might make sense for you. However, look for a 3/27 ARM without any prepayment penalties. Otherwise, a prepayment penalty could make it very costly to get out of the mortgage.

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