Two-Step Mortgages

A two-step mortgage, sometimes called a hybrid mortgage or a reset mortgage, is a mortgage that has two interest rates during the term of the mortgage. The total length of the mortgage is 30 years but it is divided into two parts. The first part of the mortgage, usually five or seven years, is fixed usually at a lower rate of interest than market rates. After this the rate changes, usually upward, for the rest of the 30 year period sometimes to a fixed interest rate mortgage sometimes to a variable interest rate mortgage.

Two-step mortgages are shown as 5/25 or 7/23. The first number is the fixed portion of the mortgage and the second number is the balance of the 30 year mortgage that will be adjusted after the fixed portion runs out. Many two-step mortgages come with an interest rate cap over which the interest rate for the second part of the mortgage cannot exceed. However, this cap is usually quite high with five or six percent interest rate jumps often allowed.

Advantages:

• During times of high interest rates you are not locked into a high mortgage rate for the full period of your mortgage. After the initial fixed period the balance of the mortgage will hopefully be at a reduced rate.
• The first part of the two-step mortgage is usually lower that for a 30 year fixed mortgage (but higher than a one year adjustable).
• There is less risk to the borrower as they have fixed costs for the first part of the mortgage.
• If you move often, or know you will be moving in a few years you will not have to worry about the second step of the mortgage as you will have sold the property by then.
• If you know your income will increase in the next five to seven years. You can purchase a larger home with the lower payments during the fixed portion of the mortgage knowing you can handle the remainder of the mortgage when the initial period is over.
• If your income is not enough for you to afford a 30 year fixed term mortgage you may qualify for a two-step mortgage.

Disadvantages:

• In the case where your income doesn't increase in five to seven years you will be looking at a higher interest rate mortgage that you may not be able to carry.
• If interest rates increase dramatically you will be looking at substantial payment increases. Even though interest rate caps are offered the allowable increase is usually in excess of five percent.