If you’re ready to buy a home, then you're ready to research the types of mortgage loans available. You probably know that a fixed-rate mortgage offers home buyers the security of the same interest rate over the life of the mortgage, while the adjustable-rate mortgage offers the potential of savings over time. You might not be as familiar with the split mortgage, which allows homebuyers to have the bests of both worlds. It splits the mortgage into separate terms of fixed and adjustable interest rates. It entails more than simply combining two common mortgage types. The design of the split mortgage, or hybrid ARM, and the level of customization homebuyers are allowed, varies among financial institutions.
The Fixed/Adjustable Split
Home buyers usually have a choice of 15, 20, or 30 years with the fixed-rate mortgage. The downside to the fixed-rate mortgage is your interest rate remains the same when interest rates fall in the housing market. The adjustable-rate mortgage, or ARM, includes an initial period of predetermined length during which the interest rate stays the same. After the initial period ends, the interest rates fluctuate for the remainder of the loan period. Mortgage payments under the ARM change when interest rates change. The split mortgage allows you to choose a split, such as 30/70 or 50/50, to define the loan periods during which the interest rate is fixed or adjustable.
Adjustments and Lender Margins
Lenders include several variables in the split mortgage loan contract that affect your interest rates and mortgage payment amounts. Most lenders adjust interest rates annually. However, some hybrid mortgages have three-month or six-month adjustment periods. Your lender will use an economic indicator, which is often a market index, to determine how much your interest rate adjusts. The lender’s margin, which is a markup added to the adjustable rate mortgage, also changes your mortgage payment.
Adjustable Interest-Rate Caps
Lenders use three types of interest rate caps for the ARM portion of the split mortgage. The “initial cap” limits the amount of the initial adjustment. The “periodic cap” limits all other adjustments. The “life cap” limits the total increase from the initial increase to the end of the life of the mortgage. Calculating your mortgage payment amounts over the loan period can help you determine if the variables and caps make the split mortgage a good choice for you. According to HSH.com, a publisher of loan and mortgage information for consumers, the index plus the margin equals the mortgage rate. Interest rate caps can also change the final calculation amount.
The split mortgage allows you to choose from several standard fixed-rate periods that can last up to 10 years. The splits usually offered by lenders, according to the Mortgage Banking Administration, are 3/1, 5/1, 7/1 and 10/1. For example, with a 3/1, the fixed rate period is three years, after which the adjustable rate kicks in. The conversion to an adjustable interest rate allows lenders to offer lower initial interest rates than those available for a 30-year fixed-rate mortgage. You maintain a degree of security even when the ARM period begins since adjustments are limited to a predetermined range. The Center for Personal Finance, a credit union information service, recommends hybrid mortgages for homeowners who plan to refinance or sell their homes within five to seven years of purchase.
You will enjoy the low monthly payments during your initial fixed-rate period of a split mortgage, but you could pay for it later. The Center for Personal Finance cautions that you could see significant increases in mortgage payments during the adjustable rate period. Another reason for caution is the prepayment penalty some lenders place on the home owner. The penalties, depending on the amount, can disrupt plans for early payoff of the mortgage. According to the Center for Personal Finance, a split mortgage is not the best choice for you if your plan is to remain in the home for more than 10 years.
- North Shore Credit Union: Split Rate Mortgage
- USA.gov: Common Types of Home Mortgages
- Credit Union National Association: Is a Hybrid Mortgage Right for You?
- Mortgage Bankers Association: FHA Single Family Hybrid Adjustable Rate Mortgages (ARMs)
- HSH.com: The Hybrid Adjustable Rate Mortgage: Four Key Questions to Ask
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