When first deciding on the type of VA loan, the initial decision is likely to select a fixed rate or an adjustable rate loan, or ARM. There are some basic questions that need to be answered when deciding between the two and still sometimes even when those questions are answered its still almost a toss-up. The Federal Reserves Quantitative Easing program combined with a rather tepid economy has helped keep interest rates as low as they are for at least a couple of years. So which do you choose: fixed or adjustable?
Generally speaking, when deciding between a fixed rate and an ARM, if rates are at or near historic lows at the time an interest rate is being locked in, the fixed rate is probably the better choice. On the other hand, if interest rates are at relative highs, then perhaps an ARM is the ideal loan.
Yet the way mortgage rates have been for the past decade, that sage advice may not always apply. Back in the 1980s interest rates were in the high ‘teens, it made sense to select an ARM. Adjustable rate mortgage loans offer an initial rate that is artificially low, called a “teaser” rate, meaning the start rate for an ARM is lower than its fixed rate cousin. When rates are high and it appears theyre not going any higher, then an ARM is the selection in anticipation of falling rates. But wild interest rate swings have mostly gone away and double digit rates for conventional loans vanished around 1992 and over the past couple of years, fixed rates and adjustables were very nearly the same.
The index is a value set by third parties typically tied to things such as the London Interbank Offered Rate, or LIBOR or perhaps a one-year treasury.
The margin is a predetermined amount that is added to the index to arrive at the newly adjusted interest rate to calculate the monthly payment.
The adjustment cap is a consumer protection feature that limits how high or low a new rate can adjust based upon the index and margin.
The lifetime cap limits how high the rate may ever be throughout the life of the loan.
For example, a veteran has an adjustable rate mortgage and is set to adjust next month. The index is based upon the one-month LIBOR, the margin is 2.00 and the adjustment cap is one percent. At the adjustment date, if the index is 0.25% the new rate adjusts to 0.25 + 2.00 (margin) = 2.25%. The ARM will adjust annually and the veterans new rate will be 2.25 percent until the next adjustment the following year. Now lets say that one year later the index is 4.25%, what will the rate be for the next year? The new rate attempts to be 4.25 (index) + 2.00 (margin) = 6.25% (fully indexed rate).
Yet there is an adjustment cap of 1.00% each year, so the increase can be no greater than 1.00% above the previous rate of 2.25. Even though the rate attempts to blossom to the fully indexed rate of 6.25 it can only be 1.00% greater than the previous year.
The lifetime cap on VA ARMs is 5.00% above the initial rate so if the start, or teaser rate, is 2.50%, the rate may never be higher than 5.00 + 2.50 = 7.50, regardless of what the one-month LIBOR index is at the time of adjustment through the entire life of the loan.
Today, VA ARMs are in the form of hybrids, identified as 3/1, 5/1, 7/1 and 10/1. A hybrid is so-called because it mimics both a fixed rate and an ARM. The first digit signifies how long the rate will be fixed before it turns into an adjustable rate mortgage.
A 3/1 will have a fixed rate for three years and a 5/1 for five years and so on. After the initial fixed period, the loan will adjust annually based upon the index, margin and caps.
Is an ARM a choice today? It can be. If you think youll be moving or otherwise not have a mortgage during the initial hybrid term, it might make sense. Hybrid ARMs will have a lower rate than a fixed. Not by much, but lower nonetheless. Run your scenario by your loan officer and see how the numbers match up.
Our VA loan finder can match you with up to five rate quotes from different lenders. Check it out now!
VA adjustable rate mortgages (ARMs) are a popular mortgage option that allows eligible borrowers like veterans, active duty military, and surviving spouses to purchase a home with little to no down payment. While fixed rate mortgages maintain the same interest rate for the life of the loan, ARMs offer lower initial rates that can fluctuate over time. This guide will explain everything you need to know about VA ARMs in 2023 so you can decide if it’s the right choice for your home buying needs.
What is a VA ARM Mortgage?
A VA adjustable rate mortgage is a home loan backed by the Department of Veterans Affairs that features an interest rate that may change periodically over the life of the loan It always starts with an initial fixed interest rate and payment amount for a set period of time, usually 5, 7 or 10 years After the fixed period ends, the interest rate begins to adjust periodically based on current market rates. The frequency of adjustments is outlined in the loan terms, but usually it’s once per year.
VA ARMs are a type of hybrid ARM, offering borrowers the security of fixed payments in the beginning before switching to adjustable rates This gives homebuyers time to settle into the new property without worrying about rate hikes It provides payment stability when needed most in the early years of repayment.
How Do VA ARMs Work?
VA ARMs work by providing homeowners with a fixed interest rate for the first 5, 7 or 10 years of the loan. After this initial fixed-rate period ends, the mortgage converts to an adjustable rate that can change every year based on the terms.
The interest rate fluctuations are tied to an index, typically the 1-year Constant Maturity Treasury (CMT) rate. On each adjustment date, the lender will take the CMT rate and add a pre-determined margin to it. This new rate becomes the new interest rate for the next 12 months.
Most ARMs also have periodic and lifetime “caps” that limit rate changes. For example, a common 5/1 ARM cap structure is 1/1/5 – meaning the rate can adjust up or down 1% at the first adjustment, 1% every year after that, with a 5% max increase or decrease over the life of the loan.
VA ARMs can be an attractive option because the initial fixed-rate period allows you to lock in a lower rate than a fixed rate mortgage. This gives you time to pay down the principal before any rate changes occur.
Pros and Cons of VA ARMs
There are several key pros and cons to weigh when considering a VA adjustable rate mortgage:
Pros
- Lower initial fixed interest rate
- Pay down mortgage principal faster in early years
- Ideal if not planning to stay in home long-term
- Provides greater flexibility to refinance later
Cons
- Uncertainty of payments adjusting yearly
- Interest rates and payments may increase over time
- Lifetime rate caps limit downward adjustments
- Higher monthly payments after fixed period ends
- Requires solid credit and finances to refinance later
Overall, VA ARMs offer eligible borrowers the chance to secure a lower starting rate and accelerate paydown of principal in the first 5-10 years. This can lead to considerable interest savings over the life of the loan. However, borrowers must be prepared for the risk of rising rates after the fixed period ends.
How to Calculate VA ARM Payments
You can calculate the initial monthly payments of a VA ARM using the starting loan balance, fixed interest rate, and loan repayment term. This gives you the fixed monthly payment for the first 5-10 years.
Once the initial fixed period ends, calculating the new adjusted payment requires a few steps:
- Note the index rate (usually 1-year CMT) on the rate adjustment date
- Add the lender’s pre-set margin to the index rate
- Apply the periodic rate caps to determine the new interest rate
- Recalculate the monthly payment based on the remaining loan balance and new rate
Lenders often provide VA ARM payment calculators to estimate how adjustments will impact monthly payments. Getting multiple scenarios of future rate changes can help you budget for surprises down the road.
How to Qualify for a VA ARM
To qualify for a VA adjustable rate mortgage, borrowers must meet VA eligibility requirements as well as criteria set by the lender:
- Meet VA loan requirements like service history, occupancy, and loan limits
- Have a minimum credit score of 620 or higher
- Sufficient income and employment history
- Manageable debt-to-income ratio (ideally under 41%)
- Be comfortable with the risks of rising payments over time
VA loans require no down payment for qualified applicants. But borrowers with 10-20% down may receive improved loan terms from lenders.
Getting pre-approved makes the mortgage process faster and shows sellers you are a serious buyer when making an offer.
Tips for Managing a VA ARM
If you decide on a VA adjustable rate mortgage, here are some tips to manage the up and down swings in rates and payments:
- Make extra principal payments during the fixed rate period
- Build up your emergency savings fund
- Refinance into a fixed rate loan before adjustable period begins
- Review new rates annually and adjust monthly budget accordingly
- Consider refinancing if rates decrease and it makes financial sense
Staying proactive with your VA ARM can save money on interest and avoid payment shocks as your loan shifts from fixed to adjustable rates.
Alternatives to a VA ARM
Some alternatives to consider beyond a VA adjustable rate mortgage include:
VA Fixed Rate Mortgage – Offers predictable monthly payments but generally has a higher rate than an ARM. You won’t risk any rate increases.
VA Hybrid ARM – Combines features of fixed and adjustable mortgages. Allows you to lock in a fixed rate for 5-10 years before shifting to a variable rate. Provides greater initial rate/payment stability.
VA Streamline Refinance – Refinance into a new VA loan at lower rates/payments without requiring home appraisal or credit check. Ideal for managing adjustable rate payment increases.
Conventional Loan – Explore fixed and adjustable mortgages from conventional lenders. May require a down payment and mortgage insurance.
Discuss your specific home buying situation with a qualified VA lender to determine if a VA ARM or alternative option best fits your needs and financial goals.
The Bottom Line
VA adjustable rate mortgages offer military borrowers the chance to buy a home now at a lower starting interest rate, allowing you to pay down your principal faster in the early years of homeownership. However, you trade off the certainty of fixed payments for potentially higher payments later as your interest rate fluctuates up and down.
Understanding the ins and outs of VA ARMs will empower you to make the most informed decision for your family as you take the exciting step of becoming a homeowner. Partner with a trusted VA lender to walk through the pros, cons and alternatives to find your best mortgage option.
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Is a 5/1 Adjustable-Rate Mortgage (ARM) a Good Idea?
FAQ
Does the VA offer ARM mortgages?
What is a VA hybrid ARM loan?
Is it harder to qualify for an ARM loan?
Do ARM mortgages still exist?
How do Va ARM loans work?
VA ARM loans are adjustable-rate mortgages backed by the Department of Veterans Affairs (VA). ARMs have interest rates that adjust up or down with the market after a certain period. Structurally, VA ARM loans work the same as other ARMs in terms of handling adjustments. How Do VA Adjustable-Rate Mortgages Work?
What is a VA loan & how does it work?
A **VA loan** is a mortgage guaranteed by the **U.S. Department of Veterans Affairs (VA)** and issued by a private lender, such as a bank, credit union, or mortgage company.
What is a VA adjustable-rate mortgage (ARM)?
A VA adjustable-rate mortgage (ARM) is a type of VA loan with an interest rate that changes based on market conditions.
How long is a VA ARM loan?
Though not a hard rule, most ARMs are based on 30-year terms. If you’re looking into a VA ARM loan, you might see terms like “5-year ARM.” This refers to the period during which you’ll have a fixed interest rate before your mortgage lenders make any adjustments.