A Closer Look at VA Adjustable-Rate Mortgages (ARMs)

VA adjustable-rate mortgages (ARMs) haven’t been common in recent years, but borrowers are reconsidering them as the current interest rates rise. Veterans United now offers a 5/1 VA hybrid ARM for borrowers it may fit.

A VA ARM can make good financial sense for some borrowers, especially those still serving. Below, we dive into VA ARMs and what borrowers should know about this mortgage product when purchasing a home.

Factors That Affect VA ARMs

Breaking down what affects a VA ARM loan can help you understand how your specific loan works. Here is a brief overview of what makes up a VA adjustable-rate mortgage:

• Interest rate index: A market benchmark or reference rate used to determine the VA loan interest rate charged on the loan.
• Margin: The additional interest added to the index rate to determine your total rate.
• Initial fixed-rate period: The duration your rate remains fixed before it can adjust. (For example, 5 years in a 5/1 ARM).
• Adjustment cap: Limits the amount your rate can increase at each adjustment, typically around 1-2% per adjustment, although this varies by lender.
• Index lookback period: The time frame lenders use to determine the index value before your next rate change.
• Rate adjustment frequency: How often your rate can change after the fixed period ends. VA ARMs adjust annually, meaning your rate can change only once a year. In a 5/1 ARM, the "5" is the number of years your rate stays fixed, and the "1" means it can adjust once every year after that, for the life of the loan.

It's important to note that the terms and conditions of VA adjustable-rate mortgage loans can vary among lenders, so borrowers should carefully review and understand the specific terms offered by their chosen lender before committing to a loan.

Borrowers should consider their unique circumstances and financial goals when choosing a VA ARM. Veterans United offers the 5/1 VA hybrid ARM, along with fixed-rate mortgages with terms of 15, 20, 25 or 30 years. The 5/1 VA hybrid ARM is available on 30-year terms. It isn't available for homes in California or Washington, D.C., for refinances in Texas or with a temporary buydown. A Veterans United loan expert can confirm whether it's an option for you.

In general, consulting with a knowledgeable lender can help borrowers select the most suitable option based on their needs and financial outlook.

VA Hybrid ARM

VA ARM loans are usually hybrid loans. These have a fixed interest rate for a specific period before becoming eligible for annual adjustments. This period allows homeowners to settle into their new property without worrying about interest rate fluctuations.

Once the initial fixed-rate period ends, the loan transitions to an adjustable-rate loan. Afterward, the interest rate is recalculated at predetermined intervals, such as annually or semi-annually.

For example, a 5/1 VA hybrid ARM features a fixed interest rate for five years, then reverts to the traditional setup. That period of fixed interest gives borrowers an initial degree of certainty regarding their payments.

For homeowners who expect to move or refinance before the adjustable period begins, VA hybrid ARMs can be an attractive option. They provide an opportunity to enjoy the benefits of a lower fixed rate initially while taking advantage of potential market changes or financial growth.

VA ARM Requirements

When considering a VA adjustable-rate mortgage, there is criteria borrowers need to meet. Here's a list of common financial requirements lenders look for when trying to get a VA ARM:

• Creditworthiness: While the VA does not set a specific credit score requirement, lenders typically look for a solid credit history with a satisfactory credit score, typically around 620.
• Income and employment stability: Lenders review employment history and income stability, which may require verification through pay stubs, W-2 forms or tax returns.
• Debt-to-income ratio (DTI): This ratio compares monthly debt obligations to gross monthly income. VA doesn't set a maximum debt-to-income (DTI) ratio. Instead, it uses 41% as a benchmark. Loans above that level get a closer look, and borrowers typically need compensating factors. Individual lenders may also set their own DTI limits.
• Loan-to-value ratio (LTV): This compares the loan amount to the property's appraised value. LTV limits for ARMs can vary by lender and loan type, and some lenders set a lower maximum LTV for ARMs than for fixed-rate mortgages. A lower LTV generally means less risk for the lender, which may result in more favorable loan terms.

It's worth noting that these requirements can vary by lender, and some may have additional criteria or overlays. Borrowers must also meet VA loan eligibility and Minimum Property Requirements. Working with a knowledgeable VA-approved lender is crucial to understanding and meeting the requirements.

Refinancing a VA ARM and IRRRL

Many people choose an ARM with a plan to refinance or sell before their rate adjusts. Refinancing into a fixed-rate loan can protect you from future rate increases or let you take advantage of lower rates if the market drops. Some borrowers refinance during the fixed period to lock in a predictable payment, while others wait for rates to fall or their credit to improve. Either way, these plans depend on interest rates, home values and your finances at the time, so it's smart to make sure you could handle the adjusted payment if you end up keeping the loan.

VA borrowers also have access to the Interest Rate Reduction Refinance Loan (IRRRL), which is a streamlined option designed to lower your interest rate with minimal paperwork. In many cases, the IRRRL doesn’t require a VA appraisal or income verification and allows you to move from an ARM to a fixed-rate loan quickly with fewer costs. This makes it one of the easiest ways for ARM borrowers to secure long-term payment stability.

Keep in mind that refinancing typically includes closing costs, although many borrowers choose to roll them into the loan. A qualified VA lender can help you compare costs and long-term savings to determine whether refinancing your ARM makes financial sense for you.

Note: Refinancing may result in higher finance charges over the life of the loan.

How To Calculate Your VA ARM Payments

Calculating VA adjustable-rate mortgage payments can be straightforward and offers potential advantages for borrowers. Here is a list of steps Veterans United has compiled to help with your ARM monthly payment:

1. Start by gathering the necessary loan details: This includes the loan amount, the interest rate during the fixed-rate period, the length of the fixed-rate period and the adjustment caps specified in the loan terms.

2. Calculate your initial payment: Use a mortgage calculator to estimate your monthly payment during the fixed-rate period. A VA loan calculator can be helpful since it accounts for the VA funding fee, which conventional calculators may not include. Keep in mind that VA loans don't require private mortgage insurance (PMI), and some Veterans may be exempt from the funding fee based on disability status.

3. Understand the adjustment rules: Know how much your rate can change and how often.

4. Plan for changes: Your rate won’t automatically climb after the fixed period since ARMs can move up or down. Many ARMs limit annual rate changes to around 1%, so budgeting for a possible 1% increase after the fixed period passes will keep you covered regardless of how the market shifts.

5. Monitor rates: Track market trends so you can refinance if rates start rising. Keeping an eye on interest rate trends allows you to anticipate potential payment changes and plan accordingly.

For example, let's say you take out a $300,000 5/1 VA hybrid ARM with a 30-year term and an initial fixed rate of 5.25% for the first five years.

• Your monthly principal and interest payment would be about $1,657 during that time. This figure doesn't include property taxes, homeowners insurance or other costs like HOA dues, so your actual monthly payment may be higher.
• After year 5, your rate adjusts annually based on the loan's index and margin.
• If market rates rise by 1% at the first adjustment, your new rate becomes 6.25% and your principal and interest payment would increase to roughly $1,824 (based on your remaining balance). That's a difference of about $167 per month.

Interested in a 5/1 VA hybrid ARM? Connect with a Veterans United VA loan expert to talk through your options. They can estimate your monthly payments, walk through your timeline and goals and show you how your payment could change under your specific loan terms so you can decide whether an ARM is a good fit for you.