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 (ARM). The current 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 $250,000, 30-year, fixed-rate loan at 5 percent would have a monthly payment of $1,342, while a $250,000, 7/1 ARM with an initial rate of 4 percent would have a monthly payment of $1,193. The difference, $149 per month, totals $12,516 in seven 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.