What is the VA ARM and How to Utilize it?

VA ARM: What It Is And What It Entails For The Borrower

VA loans stand out as one of the limited financing options allowing the purchase or refinancing of a home without needing any down payment or equity. This exceptional advantage is available to eligible active duty service members, certain reservists, veterans, and those recognized by the VA as surviving spouses. While you can opt for a fixed rate, there are compelling reasons to consider adjustable-rate mortgages (ARMs) and VA ARMs specifically.

What Exactly Is A VA Adjustable-Rate Mortgage?

Adjustable-rate mortgages (ARMs) come with interest rates subject to change over time, including both hybrid and variable rates. While fully variable rate mortgages, which may adjust monthly, are less common, hybrid ARMs are more prevalent. These start with a fixed

interest rate for an initial period, after which they adjust at predetermined intervals.

VA ARMs fall into the category of hybrid ARMs, starting with a fixed interest rate for a set number of years before transitioning to annual adjustments. Elevation Mortgage for instance, provides 5/1 ARMs under VA loans, locking in the rate for the first five years and then adjusting it annually based on a specific index thereafter. Typically, these ARMs have a 30-year term length.

The initial lower rate is partly because investors don’t need to forecast long-term interest rate fluctuations due to inflation, unlike with 30-year fixed-rate loans. In contrast, the principal and interest payment of a fixed-rate mortgage remains constant, offering stability even though taxes and homeowners insurance might vary.

How Do VA ARMs Operate?

While different lenders may present various ARM options for VA loans, let’s discuss the 5/1 ARM as an example. The “5” denotes the initial fixed-rate period in years, and the “1” indicates the annual rate adjustment after the fixed period.

Adjustments in VA ARMs are linked to an index known as the constant maturity treasury. On adjustment day, this index, plus a margin, determines your new interest rate, affecting your payments until the next adjustment. With each adjustment, the loan is re-amortized to reflect the new rate and the remaining loan term, recalculating your payment based on the remaining years.

Rate adjustments are capped to prevent drastic changes. A typical cap structure is 1/1/5, meaning the rate can initially adjust by up to 1%, then by 1% annually, with a total adjustment limit of 5% over the loan’s life.

Qualification for a VA ARM is based on the initial rate specified in your mortgage note, influencing your potential loan amount. It’s worth noting that VA ARMs can later be refinanced into fixed-rate loans, emphasizing the importance of maintaining good credit to ensure future financing options. Elevation Mortgage requires a minimum median credit score of 500 for qualification.

Advantages and Disadvantages of VA ARM Loans

Exploring the benefits and drawbacks of VA ARM loans offers a comprehensive understanding of their impact on homeowners.

Advantages

• Ideal for Short-Term Homeowners: For those viewing their current home as a temporary residence, VA ARMs are beneficial due to the initial lower fixed interest rates. This feature is particularly advantageous if you plan to relocate before the rate adjusts.    
• Lower Initial Fixed Rate: The introductory lower rate allows for significant savings, enabling borrowers to allocate more funds towards the loan’s principal. This strategic payment can result in a reduced balance when the interest rate adjusts.
• Rate Caps: These loans come with safeguards—caps that limit the annual and lifetime interest rate increases, ensuring that borrowers are not overwhelmed by unmanageable rate hikes regardless of market conditions.

Disadvantages

• Uncertain Future Payments: Unlike fixed-rate mortgages, VA ARMs lack predictability in future payments. While there’s a chance for rates to decrease, there’s also a risk of facing higher rates and payments.
• Double-Edged Caps: While caps protect against steep rate increases, they also limit the potential for significant decreases in payments. This limitation isparticularly relevant in highly volatile markets where rapid rate drops could otherwise benefit borrowers.

Calculating Your VA ARM Payments

To estimate your initial VA ARM payment, you’ll need the starting balance (potentially the home’s purchase price), the initial interest rate, and the loan term. This calculation is

straightforward with an amortization calculator and can be repeated at each rate adjustment using the new rate, remaining balance, and remaining term.

Planning for the maximum possible payment—based on the highest capped rate—can help ensure financial readiness for any scenario.

When considering a VA ARM loan,prepare to provide detailed information about your income and assets and ensure your credit is in good standing. While the VA does not set a minimum credit score requirement, lenders typically do. For instance, Elevation Mortgage stipulates a minimum credit score of 500.

Your eligibility for a specific interest rate will depend on various factors, including your credit score and whether you’re making a down payment. Gathering all necessary documents in advance will streamline the application process for a mortgage.

The Bottom Line

VA ARMs share many characteristics with other types of adjustable-rate mortgages, including their benefits and drawbacks. They typically offer a lower initial fixed interest rate for the first few years, as the possibility of future adjustments aligns them closer to prevailing market rates once the fixed period concludes. It’s crucial to understand that there are caps in place that restrict how significantly your rate can fluctuate once it begins adjusting.

A key advantage of opting for a VA ARM is the potential savings from the lower interest rate during the loan’s initial phase. This could be particularly beneficial if you plan to relocate before the rate starts adjusting. Moreover, the initial savings could enable you to reduce your loan principal more significantly, leading to substantial interest savings over time.

However, the trade-offs include a lack of predictability regarding future payments and the dual-edged nature of rate caps—they not only prevent sharp payment increases but also limit the potential decrease in payments when interest rates drop favorably.

If a VA ARM seems like it might fit your financial situation, you’re encouraged to begin the process online or reach out by calling (719) 247-6622. Exploring various VA loan options may also be beneficial.