Take a risk
A second option is a "hybrid" loan that's fixed for an initial period of three, five, seven or 10 years, and then converts into an adjustable-rate mortgage, or ARM. The typical difference, or "spread," between the rate on a 30-year loan and the rate on a hybrid ARM makes this type of loan "very desirable," says Leif Thomsen, CEO of Mortgage Master in Walpole, Mass.
The savings can be significant. For example, a $200,000 30-year fixed-rate loan at 4.25 percent would have a monthly principal and interest payment of $938.88, while a $200,000 5/1 ARM with an initial rate of 3.25 percent would have a monthly payment of $870.41. The difference, $68.47 a month, totals $4,108.20 over five years.
The risk is that the interest rate may be much higher after the initial term expires. If the rate skyrocketed to the limit, that "would be a disaster," Thomsen says, as the savings would be wiped out within a few years.
Borrowers who choose a hybrid loan typically plan to sell their house, refinance the loan or get a big raise before the rate adjusts. Therein lies the risk because the move or pay hike might not happen, and ability to refinance isn't guaranteed.