Hybrid loans have evolved to harness the benefits of fixed rate self-liquidating loans, but with a lower cost. Essentially, customers get the security and low monthly payments associated with 30-year fixed rate loans, without paying for a long term rate.

A fixed/balloon mortgage initially acts like a fixed rate mortgage for a set period of time (3-10 years), but after the fixed period is over, the entire loan balance is due. With a fixed/variable mortgage, the loan converts to an adjustable-rate mortgage (ARM) at the end of the fixed period.

Hybrid loans provide the safety of a fixed rate for a set time, but allow for potential uncertainty in the future. That is why these loans are particularly attractive to customers who will only need the mortgage for a specific time or who plan to refinance before the initial term is up. Medical professionals in residency or executives who relocate fairly regularly, and who can predict how long they may own a particular home, may find these loans beneficial.

The interest rates for hybrid loans are also lower than for standard 30-year fixed mortgages because there is less risk for the lender. For fixed/variable loans, the rate is lower because the lender does not have to guess what the market rates will be far into the future. With fixed/balloon loans, there is less risk because the lender knows the loan will be repaid at the end of the fixed period.

There is potentially more risk for the customer, however. With the fixed/balloon mortgage, a large amount of money will be due at once. If this occurred during a period of economic or personal financial crisis for the customer, there would be serious consequences—the least of which would be foreclosure.

To offset the risk of the balloon payment, the fixed/variable product was developed. Although the cost paid to the lender over the life of the loan is much higher than the fixed/balloon, the loan does self-liquidate. Therefore, the cost could be reduced by paying down the principal, which would decrease the monthly payments.

Overall, EMA and the customer must decide whether the lower payments and benefits associated with these hybrid loans are enough to offset future risk.

Case Study
A locally based national charity hired a new Executive Vice-President of Development. The charity executive arrived in town with her husband and teenage daughter with the expressed purpose of purchasing a home within two weeks. This was the third move the family has made due to her ascent in the charity industry.

The husband, a former real estate agent, began the search for a house and an appropriate school for their daughter. Once settled, he intended to find a job with a local commercial real estate company. Since the charity is prestigious, the family selected a home in a fashionable neighborhood within the city limits, a few blocks from an esteemed girl’s school. To help them finance the home, one of the charity’s board members referred the couple to EMA.

The Georgian style of the new home was quite different from the home they left in Santa Barbara. Therefore, furnishing and decorating the home was a significant expense. This, combined with the uncertainty of the husband’s income and the cost of the private school, created sensitivity with regard to cash flow.

After reviewing several options, they decided on a fixed/balloon mortgage. Her income was adequate for the loan amount under any mortgage configuration, and they desired to save money by accepting a lower rate with riskier terms. This was appropriate for the family because the executive believed she would make another move within seven years.

At the time the seven-year balloon was 9.1% less per month than a standard 30-year fixed rate mortgage, allowing the family to have more disposable income to spend on their home and daughter. Another option, the interest-only loan, was not ideal for them because of the additional risk involved by only paying interest, and not reducing the principal. The fixed rate/balloon does require some principal payments, but the interest rate is lower. Therefore, despite the large final payment, the fixed/balloon’s lower interest cost was ultimately the most appealing choice for this customer.