Is there any reason why I should not consider a three year adjustable rate mortgage or hybrid mortgage?

The three year adjustable rate mortgage ( ARM ) is often referred to as a hybrid loan.  The interest rate is fixed for the first three years and adjusts after that time to an adjustable rate loan for the remaining term.  The adjustable rate loan for the remaining term is based on a preset index and a margin which is an amount added to that index.  The value of this type of loan depends on the future outlook for interest rates, the present interest rate yield curve and the borrowers’ long term plans. 

There is generally a slight interest rate difference between a three year ARM and a 30 year fixed rate mortgage with the three year ARM having a lower interest rate.  The interest rate differential between a 3 Year ARM and a 30 Year Fixed Rate loan has not been very significant recently because the differences in short and mid term rates are not very wide.  The spread between interest rates based on term alone is a yield curve.  When this curve is relatively flat, the difference between interest rates on different mortgage terms is not very significant.  When spreads are narrow, the three year ARM has fewer benefits.  If the outlook for rates is for an increase, the benefits of the three year ARM become even less.  A borrower who intends to stay in their home for three years or less may accept the small rate differential as an added bonus but if the borrower intends to hold onto the home, the risk of a higher monthly mortgage payment should rates rise can not be discounted.

To find out if you might be better served with the fixed rate mortgage loan or the hybrid loan, enter the data on these loans into a mortgage calculator.  When entering the data, use a mortgage calculator that compares a fixed rate mortgage to an adjustable rate mortgage to evaluate payments differences and have the ability to change the interest rate to account for interest rate changes that may incur on the three year ARM.

This entry was posted on Monday, December 8th, 2008 at 9:56 pm and is filed under Mortgage FAQs. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.