Similar to other adjustable-rate mortgages, hybrid ARM’s have a payout period of 30 years with an interest rate that adjusts periodically. With a hybrid loan, the first rate adjustment is delayed from between one and 10 years, after which the rate adjusts annually.

As consumers drive much of the demand in the market, many products and services correlate directly to rising interest rates and the increasing cost of differential between standard, fixed mortgages and ARMs. Although decreasing rates and slow economic growth play large roles in ARM’s popularity and staying power, the market is seeing new ARM loans, including the interest-only and hybrid-ARM products. The debate centers on whether credit standards are falling too far as well as on these loans’ potential for trouble. But the bigger question is whether the right borrowers are sold the appropriate products based on their incomes and circumstances.

To better illustrate this, let us consider an example of a Florida borrower choosing between an option ARM and an interest-only, 5/1 hybrid ARM. We will assume the property value is $500,000.00 with a total loan amount of $400,000.00. The monthly US Treasury average (MTA) remains steady at 2.5%, housing appreciation stays flat and the 5/1 hybrid is originated at 5.25%. Collateral specifications of the pool are a one-month teaser rate at 1.375%, with a margin of 2.95 over the MTA.

As illustrated the borrower adds $54,200 of debt in five years with the option ARM vs. a total payment savings of $10,400. The borrower’s principal balance after the first year is $9,500 more than with the option ARM. The LTV (loan to value) increases to 91%, assuming flat housing prices, which potentially limits refinancing options. In the sixth year the recast monthly payment on the option ARM also would jump to $2,789 vs. the $1,916 for the interest only 5/1-hybrid, assuming a flat index.

Some borrowers who select the hybrid-ARM product expect a move within five years, a housing appreciation or increased income potential. A slight deviation in the interest rates, or property-value depreciation, however, can skew these borrowers’ plans, and they could face a net loss.