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Should you consider a hybrid loan?

By Kenneth Harney
Kenneth Harney
Kenneth Harney, who lives in Washington, D.C., writes an award-winning column on housing and real estate.

Higher mortgage rates for 2014? Count on it. Could this be the year to check out hybrid mortgages, which haven’t been popular lately? Maybe.

You can count on interest rates going higher because:

• The Federal Reserve intends to continue reducing its monthly purchases of mortgage bonds and Treasury securities, which will have the side effect of raising rates.

• The national economy finally appears to be picking up steam, based on the latest quarterly data. Higher growth rates in turn will increase demand for available credit and likely nudge rates higher.

• New federal regulations for mortgage lenders aimed at avoiding another bust took effect Jan. 10. Not only will loan officers and underwriters scrutinize applicants’ income, debt ratios and credit extra carefully, they'll likely charge more for borrowers whom they see as a higher risk. Some mortgage economists predict that conventional 30-year fixed-rate loans could go to 5.5 percent before year-end.

So what does this mean for you if you’re thinking about buying a house or refinancing and you want to nail down the most favorable interest rate and terms? Should you shop primarily for a traditional mortgage product that guarantees you a specific rate for 15 to 30 years?

Or should you check out what’s also on the shelf in the way of hybrids – loans that provide you a guaranteed fixed rate for a predefined period of time, say five, seven or 10 years – then convert to a rate that can change annually?

The case for sticking with a traditional, fixed-rate mortgage is straightforward. Though 30-year rates are more than a percentage point higher this month than they were a year earlier, they are still not far off multidecade lows. Bruce A. Calabrese, president of Equitable Mortgage Corp. in Columbus, Ohio, is adamant: “My advice for homebuyers” in the new year, he says, “is to lock early into a 30-year fixed” while rates are still under 5 percent. “Take a 30-year fixed at 4.75 percent and be happy” because that’s still far below average rates over the past several decades.

Paul Skeens, president of Colonial Mortgage Corp in Waldorf, Md., agrees. “If fixed rates are under 5.5 percent and you are going to live in your home for five years or more, they are still a great deal,” he says. “I’m very partial to fixed rates since I remember when anything under 7 percent was a great deal.”

To illustrate Skeens’ and Calabrese’s historical point, consider these average annual 30-year fixed rates: In 1974, they averaged 9.19 percent nationwide, according to mortgage investor Freddie Mac. By 1984, they were at 13.88 percent. In 1994, fixed rates averaged 8.38 percent; and in 2004, 5.84 percent.

But what if you say: I don’t care about what rates were in previous decades. That was then. I’m here and now. I’m more concerned about being able to afford today’s housing prices on today’s income and household expenses.

Jeff Lipes, a lender in the Hartford, Conn., area and former president of the Connecticut Mortgage Bankers Association, believes that hybrids with fixed rates for between five and 10 years “are fantastic options for borrowers” in 2014, and can lock in rates that are one or more percentage points below competing 30-year fixed loans.

“Most first-time buyers purchase a home that will be sold when the family income increases or the family outgrows the house,” Lipes says. “That usually occurs in the first 10 years, so that is why a hybrid is a great option. The borrower saves a lot of money” – sometimes hundreds of dollars a month – “paying a lower rate.”

A check of Bankrate.com’s online rate monitor in late December found five-year hybrids averaging around 3.4 percent nationwide, seven-year hybrids at 3.81 percent and 10-year hybrids at 4.16 percent. Thirty-year fixed rates averaged 4.63 percent.

Ted Rood, senior mortgage consultant with Wintrust Mortgage in St. Louis, says he’s already seeing a shift in demand toward five- and seven-year hybrids. He just closed a seven-year at 3.5 percent on a house in Wyoming for a borrower who fully understood the risk that he could face higher rates at the conversion point in late 2020.

Bottom line for you if you’re in the market: Check out all the options on the menu. If you are comfortable with the potential risks, and the monthly savings advantages of a hybrid are substantial, go for it.

kenharney@earthlink.net
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