What is a Hybrid Mortgage?

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A hybrid mortgage blends elements of both a conventional, fixed-rate mortgage and an adjustable-rate mortgage (ARM). Hybrid mortgages aren’t for everyone but could be a good option depending on your financial goals.

What are hybrid mortgages?

The most common type of home loan is a 30-year, fixed-rate mortgage, meaning your interest rate never changes — unless you refinance. An adjustable-rate mortgage is one where your rate fluctuates over the loan. A hybrid mortgage, by contrast, essentially combines those two types of mortgages into one.

You may also hear a hybrid mortgage referred to as a hybrid adjustable-rate mortgage, hybrid ARM or fixed-period ARM. These terms mean your mortgage carries a fixed interest rate for a set time (often three, five or seven years) at the beginning of the loan. After that, the loan converts to a variable rate, which is “adjusted” periodically for the rest of the loan term.

How do hybrid mortgages work?

If you’re looking into a hybrid home loan, you’ll most commonly see them expressed as 3/1, 5/1, 7/1 or 10/1, although there are many other variations, such as a 5/6. The first number represents the number of years your mortgage stays at a fixed interest rate, and the second number represents how often your interest rate can be adjusted going forward.

For example, if you have a 30-year, 5/1 hybrid ARM, your interest rate is fixed for the first five years. After the five years are up, the lender can adjust your interest rate every year for the next 25 years. If you had a 5/6 hybrid home loan, the lender can adjust your interest rate every six months.

The main draw of a hybrid adjustable-rate mortgage is that you’ll typically get a better initial interest rate than you could with a conventional, 30-year fixed-interest-rate mortgage. However, it’s difficult to predict if interest rates will rise or fall in the future, so you could wind up with a significantly higher interest rate after the initial period. This change would result in a bigger monthly mortgage payment, which can be hard to budget for.

How do hybrid ARM interest rates work?

Lenders who deal in hybrid mortgages calculate your adjustable interest rate — that is, the rate after your initial, fixed-rate period — by taking into account two components:

1. Index. Your index is essentially a standard interest rate indicative of overall market conditions and fluctuates as the market changes.
2. Margin. The margin is the number of percentage points a lender adds to the index rate. For example, if the index rate is 5% and the lender’s margin is 2%, your interest rate would be 7%.

Interest rates and payment caps

Even though lenders can change your interest rate on a hybrid ARM periodically, they have limits. These limits are known as caps, and the lender cannot exceed the caps. There are three types of caps, as explained by the Consumer Financial Protection Bureau (CFPB):

• Initial adjustment cap. The initial cap limits how much your lender can increase your rate for the first time after the fixed-rate period. For example, the contract may stipulate that the lender can’t raise your interest rate by more than two percentage points.
• Subsequent adjustment cap. This cap limits how much the lender can increase your rate for the periods after the initial adjustment. Again, this could be another two points.
• Lifetime adjustment cap. The lifetime cap describes the total amount your rate can increase over the loan. According to the CFPB, a common lifetime cap is 5%, which means lenders can’t raise your rate more than 5% over your initial interest rate, although some lenders may have a higher cap.

PRO TIP

Caps and interest rates vary. Before you apply, ask your lender to calculate the highest possible monthly payment you might face. This information can also be found in the Truth-in-Lending disclosure that lenders are required to give you within three business days after you apply.

Which types of home loans offer hybrid mortgages?

Several loan programs offer hybrid adjustable-rate mortgages.

FHA loans

The Federal Housing Authority (FHA) offers hybrid ARMs to qualified borrowers, and you might get a better deal than with conventional mortgage lenders. The FHA has hybrid mortgages of three, five, seven and 10 years.

Three-year hybrid ARMs can increase by one percentage point each year after the initial fixed-rate period and are capped at five points for the life of the loan. Hybrid home loans of five, seven or 10 years can increase by two points annually after the fixed-rate period is up, and the lifetime cap is six percentage points over the initial rate.

VA loans

The US Department of Veterans Affairs (VA) also offers hybrid mortgages with ARMs of three, five, seven and 10 years. But all VA hybrid home loans are capped at 1% per adjustment period, up to a total increase of five percentage points.

Conventional loans

Lenders that offer conventional mortgages have more leeway than government-backed lending programs. But, in general, you might see increases of two percentage points per adjustment period with a lifetime cap of five or six points.

Conventional lenders can also offer a wider variety of hybrid mortgages, such as 5/5 hybrid ARM, where the interest rate adjusts every five years after the fixed-rate period. Another option might be a 15/15 hybrid home loan where the interest rate adjusts only once throughout the loan.

Who are hybrid mortgages best for?

A hybrid adjustable rate mortgage isn’t right for everyone, but it might make sense in certain situations.

• You plan to sell after a few years. If you know you’ll move within a few years, there is virtually no risk in getting a hybrid mortgage. As long as you sell before the adjustment rate is triggered, you can take advantage of a lower initial interest rate.
• You plan to pay the house off before the adjusted rate kicks in. If you have a ten-year fixed-rate hybrid mortgage, for instance, and plan to pay it off before the ten years are up, a hybrid ARM might make sense.
• You think interest rates are going down. If interest rates are high when you buy your house, but you expect them to go down within a few years, a hybrid ARM could be a good strategy. However, interest rates are based on market conditions, which can be very hard to predict, making this a somewhat risky approach.
• You expect your income to increase. Perhaps you’re in law school when you first buy a house but expect to make a lot of money once you graduate. In that case, you’ll likely be positioned to manage the potentially higher mortgage payments.

Pros and cons of hybrid mortgages

Consider the potential advantages and disadvantages of a hybrid mortgage before you decide if it’s the right move for you.

Pros

• Lower initial interest rate
• Smaller monthly mortgage payments for the beginning years
• Rate caps limit how high interest rates can go
• If interest rates drop, you could see lower payments down the road

Cons

• Potential for high rate increases after fixed-rate period
• Larger (and fluctuating) payments can be hard to budget for
• Potential for foreclosure if you can’t make the higher mortgage payments

Can anyone get a hybrid mortgage?

Just like with other types of mortgages, not everyone can qualify for a home loan. At a minimum, you’ll need a good credit score, regular income and enough cash for a down payment. You may be able to qualify for a VA or FHA hybrid home loan, which can have more lenient borrower requirements, but you’ll need to meet other criteria.

Bottom line

While a hybrid adjustable-rate mortgage isn’t the right type of home loan for everyone, it could be a good strategy when mortgage rates are high because you might get a better deal. It can also be a smart move if you plan to sell within a few years to sidestep the adjustment period.

However, a hybrid ARM is typically not the best idea if you plan on staying in the house for the foreseeable future — and can’t pay it off early. In that case, you may want to explore more conventional home loan options.

Frequently asked questions

Can you get a hybrid home equity loan?

You can get a hybrid home equity loan, but it will most often be in the form of an equity line of credit rather than a lump sum loan. Lenders who offer hybrid HELOCs vary in exactly how they handle these loans, but you may see a fixed rate for the first year of the draw period or be able to allocate a portion of your loan balance to a fixed rate.

Does the USDA offer hybrid mortgages?

The US Department of Agriculture (USDA) offers loan programs to low-income individuals and families in eligible rural areas, but it does not offer assistance with hybrid mortgages at this time.

Why are hybrid mortgages more popular now?

Adjustable-rate mortgages fell out of favor after the housing crash in 2007 and 2008. But the initial lower rates that come with hybrid ARMs — plus added safety features and greater transparency — have become more attractive to homebuyers as interest rates have risen dramatically in the last few years.

Are there other types of hybrid loans?

Hybrid loans also come in the form of hybrid personal loans and hybrid business loans.