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Current time:0:00Total duration:4:58

Video transcript

In the last video, we covered the basics of what an Adjustable Rate Mortgage is and how it's different from a Fixed Rate Mortgage. But you may have heard another term that seems to be a mixture of the two! And that is a Hybrid "ARM" or Hybrid Adjustable Rate Mortgage. And a 'Hybrid', when we use the word generally, means a mix of things. And that's exactly what a 'Hybrid ARM' is: It's a 'mix' of Fixed (it's a mix, it's a mix) of Fixed & Adjustable, and an Adjustable Rate Mortgage. So what do we mean by "mix of a Fixed and Adjustable Rate Mortgage"? Well, you might hear something like a, 5-1, a 5-1 Hybrid ARM. What does that mean? Well that means that the first 5 years of a Mortgage, it behaves like a Fixed Mortgage, and then after that it becomes Adjustable. So in the case that we used in the video on Adjustable Rate Mortgages, we saw that as your benchmark one year treasury rate fluctuates, that every year your Adjustable Rate Mortgage resets. And if interest rates go high enough, it might become unfavorable relative to the Fixed Rate. And this was just for the scenario that we were looking at. Well, in the 5-1 Hybrid ARM, what happened is that the first 5 years, it's a Fixed Rate Mortgage, and then after that it adjusts, it adjusts as 1, 2, 3, 4, 5... So the first 5 years, it's a Fixed Rate Mortgage, and then after that it adjusts just like an Adjustable Rate. And if it has the same properties as the Adjustable Rate that we saw in the video on Adjustable Rate Mortgages, then we start adjusting. So that's for that year, and then the year after that, maybe this year interest rates have gone down a little bit so we pay a premium over the treasury... So we start adjusting. So question is, why would someone want to do this? One, why would a borrower want to do this? And then, why does a bank do it? When we talked about Adjustable Rate Mortgages, we talked about this idea of interest rate risk, that in an Adjustable Rate Mortgage, a borrower takes on the interest rate risk. If interest rates go up, the borrower will have to pay more interest but the lender is protected. On the other hand, for a Fixed Rate, if interest rates go up, it's the lender who has to take on that risk, while the borrower is protected. While with a Hybrid, it's in-between. The first 5 years, the borrower is protected. They know that "Hey look! I know what my payment is going to be for those 5 years, and then after that, it adjusts." And that's also from a lender's point of view. They're like, "Okay. We'll take on the interest rate risk for the first 5 years but then after that, because it is really hard to predict what interest rates are going to be doing in 5 or 6 or 7 or 10 or 15 years, then it floats and the borrower takes it on." It's not even the case that the borrower initially even has to take on this risk. It could be the case that the borrower is buying some type of a property, where they think that they will either sell the property, or maybe they'll refinance the property. But especially if they think they're going to sell the property in the next 5 years, this could make a lot of sense, especially if they get a lower rate than they would've gotten with a Fixed Rate. For example, the rate that they might've gotten might've have looked something more like, it might've been a lower rate than the Fixed Rate, very likely for the same credit risk, it might've been a lower rate. And then after 5 years that's a lower rate because the bank is taking on less of the interest rate risk especially when you go out or when you go out beyond your 5. And then it would adjust. So the incentive is okay! If I think I'm going to sell this house or refinance this house which means take another loan to pay this loan off, if I think I'm going to be able to do either of those things in the next 5 years, maybe it makes a lot of sense for me to do this. So in a Hybrid, both parties are kind of mixing - they're both taking different pieces of the interest rate risk and once again, depending on your scenario, it might make sense to think about something like a Hybrid ARM, if you feel very confident that you can either take on the variable risk - the interest rate risk - that will happen after your 5, or you think that this property is going to be something that you might own or ... that you'll only own for the next 5 years, or that you might refinance in some way, or maybe you'll be able to pay it off, maybe you're expecting an inheritance in your 4, and so you can just pay off the property or pay off the loan, & you won't have to worry about all of this business right over here.