Two-Step Mortgages

A two-step mortgage basically applies two different interest rates at two separate times. A two-step mortgage has the same interest rate for a set period of time, usually for the first five or seven years. After the initial time period, the interest rate is adjusted, usually upward, for the remaining term of the mortgage. And while this type of mortgage typically has a cap on the increase in the interest rate at the end of the initial period, the jump can be substantial.

There are several scenarios where you may want to consider using a two-step mortgage to purchase a home. If mortgage interest rates are high, consider a two-step mortgage because you will not be locked into the same high rate for the entire mortgage term. Another example of when it may be beneficial to consider a two-step mortgage is if you are relatively certain that you will sell your home before the end of the initial fixed interest rate time period. If you sell before the end of the initial fixed interest rate time period, you won't have to deal with the uncertainty of the "second-step" interest rate.

Buyers who aren't eligible for a conventional fixed rate mortgage may be good candidates for a two-step mortgage. This is particularly true if income is projected to increase by the end of the initial term, making it possible to afford larger mortage payments at that time.