Two Step Mortgage
A two-step mortgage is a type of adjustable-rate
mortgage (ARM) in which the borrower receives a below-market interest rate for a
set amount of years and then receives a new adjusted interest rate for the rest
of the
mortgage
term. When the new interest rate is adjusted, the borrower has
the option of selecting an adjustable-rate mortgage that will periodically
fluctuate each year depending on a predetermined index, or a fixed-rate
mortgage. Essentially, a two-step
mortgage
offers borrowers the benefits of both
a fixed- and an adjustable-rate mortgage. The borrower can enjoy the stability
of a fixed-rate loan during the initial period of the mortgage term at a lower
rate.
The most common combinations of two-step mortgages are
5/25 and 7/23 loans. For these two mortgage loans, the initial period is five or
seven years where the interest rate is fixed. After the initial period, the new
adjusted interest rate is effective for the remainder of the 25- or 23-year
mortgage term. The initial interest rate for 5/25 and 7/23 loans is usually
lower than the interest rate of a 30-year fixed loan. At the end of the initial
term, there are no refinancing fees, forms, or re-qualification required to
switch to the new
mortgage
type and interest rate. As with a conventional
adjustable rate mortgage, a two-step mortgage also usually has a maximum limit
that the interest rate can increase. This precaution protects the borrower in
case the market interest rate increases dramatically. In most cases, the new
interest rate can never increase more than a set, pre-determined number of
percentage points more than the original fixed rate.
The two-step mortgage is
best suited for homeowners who plan to stay in their home for at least the
duration of the initial period. Homeowners who most likely will stay in the home
for the entire term of the
mortgage
should be financially capable of handling
the future adjustment in their mortgage payment. For those who are certain they
will refinance or sell the home within the first period, another loan product,
such as a balloon mortgage, may be a more attractive option. Another situation
where a two-step mortgage may be a more viable option is when interest rates are
too high to lock in a rate for the entire term of the loan. Borrowers who want a
fixed-rate mortgage and predict that interest rates will drop in five or seven
years may opt for a two-step mortgage.
Mortgage Glossary3
