What is a 5-6 Variable Rate Hybrid Mortgage (5-6 Hybrid ARM)?
Variable rate hybrid mortgage 5-6 (Hybrid ARM 5-6) is a variable rate mortgage with an initial fixed interest rate of five years, after which the interest rate begins to adjust every six months according to an index plus a margin, known as the fully indexed interest rate. The index is variable, while the margin is fixed for the duration of the loan.
The 5-6 ARMs are typically linked to the six-month London Interbank Offered Rate (LIBOR), the most widely used benchmark for short-term interest rates in the world. Other popular indices for indexed rates include prime rates and constant maturity Treasury indices.
Understanding a 5-6 Variable Rate Hybrid Mortgage (5-6 Hybrid ARM)
5-6 Variable rate hybrid mortgages have several features to consider. When purchasing an ARM, the index, margin and interest rate cap structure should not be overlooked. The margin is a fixed percentage rate that is added to an indexed rate to determine the fully indexed interest rate of a variable rate mortgage. The structure of the ceilings refers to the provisions governing interest rate increases and the limits of a variable rate credit product. In a rising interest rate environment, the longer the period between interest rate review dates, the more advantageous it will be for the borrower. For example, an ARM 5-1 would be better than an ARM 5-6. The opposite would be true in an environment of falling interest rates.
In addition, most indices behave differently depending on the interest rate environment. Those with an integrated lag effect, such as the monthly average Treasury index (MTA), are more advantageous in a rising interest rate environment than short-term interest rate indices, such as the LIBOR at a month. The structure of the interest rate cap determines how quickly and how much the interest rate can adjust over the life of the mortgage. Finally, the margin is fixed for the duration of the loan, but it can often be negotiated with the lender before signing the mortgage documents.
Advantages and disadvantages of an ARM 5/6
Benefits: Many variable rate mortgages start with lower interest rates than fixed rate mortgages. This could provide the borrower with a significant savings advantage, depending on the direction of interest rates after the initial fixed period of an MRA. From a cost perspective, it might also make more sense to take an MRA, especially if a borrower intends to sell the home before the end of the MRA fixed rate period. Historically, people have spent seven to ten years in a home, so a 30-year fixed-rate mortgage may not be the best choice for many home buyers. Take the example of a newly married couple buying their first home. They know straight away that the house will be too small once they have children. Therefore, they take a 5/6 ARM knowing that they will get all the benefits of the lower interest rate because they intend to buy a larger home before or around the time. initial rate is subject to adjustment.
The inconvenients: The biggest risk associated with a 5/6 ARM is interest rate risk. It could increase every six months after the first five years of the loan, which would significantly increase the cost of monthly mortgage payments. Therefore, a borrower should estimate the maximum potential monthly payment that he could afford beyond the initial five-year period. Or, the borrower should be willing to sell or refinance the home after the fixed mortgage period has ended. Interest rate risk is mitigated to some extent by the lifetime and period caps on 5-6 ARMs. Lifetime limits limit the maximum amount that an interest rate can increase above the initial rate, while periodic limits limit the amount that the interest rate can increase during each loan adjustment period .