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Finance and capital markets
Course: Finance and capital markets > Unit 2
Lesson 3: MortgagesHybrid ARM
Explore the mechanics of hybrid adjustable-rate mortgages, which are a blend of a fixed rate mortgage and an adjustable rate in this video, including how they work and when they might be advantageous.
Want to join the conversation?
What role did Hybrid ARM loans play in the housing bubble that burst in 2008?(14 votes)
They may have had some role. If you look at the indexes that Sal mentioned in the last video, they rose sharply from 2002 to 2008. Remember that it takes a few years for a bubble to form. During all of these years, variable payments for ARM's and hybrid ARM's rose steadily. Not only were those payments increasing, but they were increasing on loans that should not have been granted to begin with (Around 2008, many debtors could not afford the payments, even before the payments increased).(6 votes)
Let's say I go with a 5-1 ARM. I get a lower interest than the fixed one, and after my 5 years are up, I see that the interest adjusts to even lower than what I was offered initially. Could I, in this case, "fix" this even better interest for another 5 years by replacing my initial contract with another 5-1 ARM contract (and doing this as many times as needed until I pay off the debt)? Cheers.(4 votes)- You can indeed do that, but there are sometimes penalties for paying off your initial mortgage early and such. Also, you will end up getting a higher expected rate, since banks tend to charge a higher interest rate for the first 5 years than they do for later years even if LIBOR doesn't change.(5 votes)
What interest rates are being compared in the ARM and Hybrid ARM videos? Is it like a specific market performance over the time-frame? Is there some market the interest rates are based off?
And why is the ARM rate 1% higher than what it is based off in these videos?(3 votes)
The ARM is based on a Treasury rate that the US Government pays. The higher ARM rate is because your typical home buyer is a bigger risk than the US Government. A one-person home buyer or one-family home buyer might lose a job or fall ill and be unable to keep up the mortgage payments. Nothing like that will happen to the US Government, so it's seen as a less-risky choice. Differences in rates almost always comes down to differences in risk.(3 votes)
- So every year after the first 5 is adjustable based on LIBOR or the treasury rate?(3 votes)
Let's say a wanted a 30 year fixed rate mortgage with a low rate. What's stopping me from taking a hybrid ARM with a 5-year fixed rate period and then refinancing with an identical loan every 5 years? I would just take another hybrid ARM identical to the first one every time I refinanced. My fixed rate would be lower, and I wouldn't have to worry about the adjustable rate because I refinance just before it takes effect.(2 votes)
what if rates go up? What if the value of your house falls and you can't refinance?
This is the thinking that got the financial crisis started. "I'll be able to refinance so why should I worry about the term of the loan"(2 votes)
Why would a country take out a loan when they could just make more money? Are many international loans through assets?(2 votes)- this is the third time ive watched this video and it will not show as done, Im not using a different video speed, its unmuted, and I can barely get it to replay the videos
(its not using the youtube player)(2 votes) 
Suppose i take a 5/1 ARM loan, I kept paying some rate for the first five years, and in those five years the interest rates went up really high, so will the bank charge more interest in the next five years, to benefit itself?(2 votes)- what does 1 in 5-1 hybrid mortgage mean?(2 votes)
When bank was creating this hybrid ARM 'product' why they came up with 5/1 ARM, why not i.e. 3/1. or 7/1?(0 votes)- Sometimes you might find 3/1 or 7/1. It just depends on what the bank wants to offer and what it thinks customers are most likely to want.(1 vote)
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.