What are Hybrid Loans?

In response to consumer demands over the years, the mortgage industry has come up with many alternative loan programs designed to fill particular needs that the more straightforward fixed rate loans and normal adjustable rate mortgages (ARMs) don't address. Many of these loans have more liberal qualifying standards than traditional loans. These "hybrid" loans include:

piggy-back loans

These loans allow people to buy a home with smaller down payments and/or to avoid private mortgage insurance (PMI). Two loans are approved concurrently: a first mortgage which is normally 80 percent of the value of the property and a second mortgage equal to 10-15 percent of the value, with your down payment making up the difference. The benefit is that your overall monthly payment will likely be less than getting a 90 percent or 95 percent LTV loan with PMI.

convertible ARMs

Some ARMs give you the option to later convert to a fixed rate. This option alleviates some of the risk of fluctuating interest rates, but remember that converting to a fixed rate usually requires a fee … and that fixed rate will probably be higher than standard fixed rates at the time of conversion.

two-step mortgages

Some lenders offer this specialized ARM which adjusts only once, at either 5 or 7 years. After that adjustment, the rate remains fixed for the remainder of the loan. The new rate will never be more than 6 percentage points higher than your initial rate, but the rate can drop as much as the market may. This option is a little bit like a fixed rate loan with an automatic refinance built in. You take the risk that rates might increase before the adjustment date, but this option gives you the advantage of a lower initial rate than a fixed rate mortgage could offer.

convertible loans

Another option somewhere between fixed and adjustable rate mortgages is convertible loans. These loans act like fixed rate loans during the first 3, 5 or 7 years, though with a generally lower interest rate, and then become adjustable rate mortgages. This type of financing might be a good idea if you expect your income to increase, or if you think interest rates will fall during the first phase of your loan.

balloon mortgages

These are short-term fixed-rate loans that begin with low, fixed payments and end with a single large payment for all remaining principal at the end of 5, 7 or 10 years. A balloon mortgage might be a good idea if you only plan to live in your home for a few years, and want to keep your housing costs low. But it can be quite difficult to save up for the final balloon payment while making interest payments on the loan. If you plan to remain in your house, you will probably have to refinance before the final payment comes due.

graduated payment mortgage (GPM)

These loans offer smaller payments at the beginning which rise regularly and level off after about 5 years. A GPM might make sense for buyers who expect their income to rise significantly in the next few years, but think carefully about this loan. Since early payments are applied only to interest, negative amortization can occur, and the loan principal might actually increase.

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