At the pre- fixed adjustment date, the borrower has an option to either choose a variable interest rate or a fixed rate.
If the borrower selects the option of a two- step mortgage, then he/ she is subjected to higher risk because the variable interest rate might have an upward shift. The borrower usually selects a two- step mortgage because
• Interest rates are high at the beginning of mortgage and expected to decrease
• If the borrower wouldn’t be in the same home for the next 5 to 7 years
• They might have plans of re- financing before the adjustment date
There would be a possibility of high savings in case interest rates reduce in the future. Types of two- step mortgage are:
5/25 year Two Step Mortgage: This is a 30 year mortgage with an initial 5- year fixed rate and the interest rate for the next 25 years is adjusted after the adjustment date.
7/ 23 year Two Step Mortgage: This is also a 30 year mortgage with an initial 7 year fixed rate and 23 year rate would be fixed at a later date i.e. after 7 years.