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Course: Personal finance > Unit 6
Lesson 2: Mortgages- Introduction to mortgage loans
- Mortgage interest rates
- Impact of credit score on interest rate
- Short sale basics
- Adjustable rate mortgages ARMs
- Hybrid ARM
- Balloon payment mortgage
- 10 questions to ask mortgage lenders
- Finite geometric series word problem: mortgage
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Hybrid ARM
Google ClassroomExplore 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.
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What role did Hybrid ARM loans play in the housing bubble that burst in 2008?(16 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).(7 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.(7 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.(4 votes)
- So every year after the first 5 is adjustable based on LIBOR or the treasury rate?(4 votes)
Depends on the country the bank you're borrowing from is. If you're borrowing from a bank in the USA, it's based on the Treasury Rate. If you're borrowing from a bank in the UK, it's based on the LIBOR.(1 vote)
- what does 1 in 5-1 hybrid mortgage mean?(3 votes)
It is fixed for 5 years. then every 1 year it adjusts.(2 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.(3 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)
- 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)(3 votes) 
Why would a country take out a loan when they could just make more money? Are many international loans through assets?(2 votes)- International Loans are probably mostly in just money, which is also considered an asset, but I get you meant to say if they give out a loan in form of a car or a house instead of money. It's more favorable to get the loan in money because you'd have to sell the other assets, plus money is easier to move around than a house haha. But sometimes they might be in a form of assets, for example USA and the EU giving a loan to Ukraine in the form of military equipment, such as tanks, guns, shells, artillery etc.
Coming back to the first question, they could make more money, but that takes time, so it's faster to take a loan and make more money faster and ideally more than the Principal + Interest.
[[[I don't have any formal Financial/Economical education, so take the next paragraphs with a grain of salt, but here's my thinking. Please someone correct me in the Comments where I'm wrong]]]
If you mean "Why don't they print more money?", is because printing money out of nowhere, faster than the economy is growing, means more money in circulation than the production, which means a disproportionately bigger supply of money, so then companies start rising the prices since there's more supply but the same demand to reach a supply-demand balance again and since production didn't increase but prices did increase, this means Inflation, or the devaluing of the whole currency.
When there's this Inflation, people are unhappy that the prices go up and so they demand higher wages to compensate. Production remains the same, but the prices are rising, and then further, wages are rising too, while production remains the same.
Since both the prices but also the wages increased, sounds like it's all back to normal, right? But this has some consequences. Some companies that didn't adapt to the inflation by rising prices but were affected by the wage increases or raised the prices to late, will be in a financially difficult situation and they might need to borrow money to get by, meaning they'll make less profit due to needing to pay an Interest now, or even close/sell the business, which may have short-term negative impact for their business partners and customers.
But the main consequence of Inflation is this: for the time and effort you've put in to earn let's say $100, you're now getting $105 for example, for the exact same time and effort. This may sound great at first, but this means that if you've saved money in the past, your past efforts are worth less now than they were in the past. It's the same thing as if your saving were slashed by 5%, because the amount you saved remained the same, but the prices increased, so relative to the current prices, you currently have less saved than you did in the past.
This is probably better exemplified by Hyperinflation. If you have $200k saved and wish to buy a $200k house, you have all the money for that house. But then Hyperinflation hits with 100% Inflation. Now the same house is $400k and you can afford only half the house. So overnight you've basically lost 50% of your savings due to (hyper)inflation.
Inflation might sound good if you have a loan too, because you can pay it back faster without doing more than you did in the past. And it is. But for the banks it's the same as the example I've gave before. The money they've lend you are worth 5% less, so they've basically lost 5% of the money due to inflation.
*(!)* Now we're getting to the important part: To make up for the losses, the banks will raise the Interest Rates (of ARMs and other Adjustable Rate Loans). And they have to take into account their loses they take on the Fixed Loans they can't change the Interest Rate for. So the Adjustable Rate Loans pay for them too, but future Fixed Loans, as well as Adjustable Rate Loans, will be issued with a higher Interest Rate.
This has the advantage of discouraging people from borrowing more, and thus there are less money in the circulation that there would otherwise be, *(!)* and this combats the artificial increase in money circulation the government created by unjustifiably printing more money than the increase in production.
*(!)* Now we're going back to the government. Because the Interest Rates increased, the Interest Rate the government has to pay also increased! So if the government doesn't make more money than they did, they either have to get in even more debt so they have to pay more in Interest, or print even more money!
Which just worsens the situation and leads to more Inflation and potentially Hyperinflation and a continuous chaotically increase in Interest Rates and the downward spiral worsens until the currency becomes basically worthless, worth less than the paper it's printed on, and people start to trade directly in goods, or in another, more stable currency, or in Gold. This leads to taxation being less effective or impossible and this means the government has even less money and it basically becomes bankrupt and I hope there's future videos on this.
This is the worst-case scenario, but sometimes governments do print money which leads to inflation, but then they stop because they invest it in things that give a bigger return than the inflation caused and they get out of this vicious cycle.
(!) Now there's also a special case, that is USA's currency: the US Dollar.
Because USA has been the biggest economy for many decades, their GDP being 54% of the entire world at the end of WW2, and their economy has been pretty stable, they've been the country where they've done more trades with other countries, than any other country. Therefore a lot of countries have US Dollars, and thus it's most convenient to trade with other countries (for example trade between India and Brazil) in US Dollars than in their national currency. It's more complicated than that but basically the US Dollar is the world's Reserve Currency through which all countries trade between each-other, out of convenience.
Because the US Dollar is the world's reserve currency, unjustifiably printing more of it inflates the prices in the entire world, not just in the USA. This effectively passes most of the problem to the rest of the world, but if there's too much instability, the countries of the world may start looking for alternatives.
The US Dollar is tied to Oil since the 1970's in agreements with Saudi Arabia and the Gulf states to tie and sell their Oil for US Dollars only, and this adds to its stability. Recently Saudi Arabia agreed to trade Oil in Chinese Yuan as well, and with China's economic rise, USA has to be even more careful than in the past, and it's interesting to see how things develop.
I'm sure this is even more complicated than anything I've talked before and there may even be factors I'm not even aware of so I'll leave it at that and hopefully there are videos about this.
TLDR: They can't unjustifiably print too much money out of thin air because it creates instability and chaos.(1 vote)
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)- The rate you and the bank agreed upon at the start of the contract, remains the same for the first 5 years no matter what happens to the Interest Rates. Starting from year 6, they will adjust/change the Interest Rate, every year.
So, yes, they will change your Interest Rate for the Loan to benefit itself, but not before the first 5 years have passed.(1 vote)
- 2. A borrower closes on a 5/1 ARM with 5/2/5/ caps. The start rate is 5.0 percent and the margin is 2.0 percent. Assuming the following index values at the beginning of each year, what is the note rate on the loan after the adjustment at the beginning of year 8?
Year 1= 5.0
Year 2= 6.0
Year 3 = 5.5
Year 4 = 6.0
Year 5 = 7.0
Year 6 = 8.0
Year 7 = 9.0
Year 8 = 5.0(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.