As you may already know, mortgage loans come in a variety of flavors, but for the most part they fall within one of two different categories, according to how the interest rate is configured – fixed-rate or adjustable-rate. 

But, did you know there is a type of mortgage which mimics both kinds.  It is called a Two-step mortgage, although it also goes by the name Super Seven mortgage, as well as Premier mortgage.  With that many names, maybe it should also be known as the Jekyll and Hyde mortgage?

Basically, the two-step mortgages is structured so that the interest rate and monthly payment stays fixed for a set period of time – most often seven to ten years.  That is the time frame most homeowners stay put before moving, according to real estate analysts.  After this initial time frame lapses, the interest rate and payment are adjusted once, according to market conditions (linked to an index or margin) – at which time, a new fixed interest rate and payment schedule begins for the remainder of the loan’s life.

Two-step mortgages have monikers attached to them, such as 2/28, 5/25, or 7/23, which correspond to the interest rate time frames.  The first number pertains to the initial period (in years), while the second number -- following the slash mark -- relates to the loan’s second period, which is the length of time remaining on the mortgage after the interest rate adjustment.  For example, a 2/28 two-step mortgage would have its interest rate adjusted after two years, and the borrower would make payments on the remaining 28 years at a different rate.

Advantages of the Two-step mortgage:

• A lower-than-market interest rate is common for the initial period of the loan
• The borrower on a tight budget can make low payments (during the initial phase of the loan).
• It allows home borrowers with less-than-stellar credit the opportunity to enter the residential real estate market.
• The borrower has the opportunity to establish better credit and qualify for better loan terms and more diverse financial products in the future
• It gives the borrower the predictability of a fixed-rate loan for each of the two time periods.
• The borrower has the option to try to refinance after establishing better credit.

Possibly, the main disadvantage of this type of mortgage is that the borrower’s interest rate can increase up to six percentage points at the end of the loan’s initial period, but it depends on how much his or her credit has improved by then.  If the homeowner’s credit hasn’t improved, he or she could be stuck with a high interest rate for 20-plus years.

 In addition, the lender, in many cases, reserves the right to demand payment of the loan’s remaining balance after giving 30 days notice from the end of the initial period.  In that respect, it can be likened to a balloon mortgage.