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.

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 over the life of the loan, 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 changes after the fixed period (usually once a year). In a 5/1 ARM, the “1” shows the rate adjusts annually after the first five years.

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 currently doesn’t offer adjustable-rate mortgages and finances fixed-rate mortgages with terms of 15, 20, 25 or 30 years. 

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 guidelines generally recommend a maximum DTI ratio of 41%, although some lenders may accept higher ratios with compensating factors.
• Loan-to-value ratio (LTV): This compares the loan amount to the property's appraised value. While the VA doesn’t specify a maximum LTV ratio for ARMs, lenders often prefer lower ratios. This indicates a lower 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 VA ARM borrowers choose to refinance before their rate adjusts. Refinancing your loan can help lock in a stable fixed rate, avoid future increases or take advantage of lower market rates. Some refinance during the fixed period to prevent future payment changes, while others wait until market rates drop or their credit profile improves.

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 increase 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 complied 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 ARM with an initial fixed rate of 5.25% for the first five years.

• Your monthly payment, covering both principal and interest, would be about $1,657 during that time.
• 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 $1,847. That’s a difference of about $190 per month.

When calculating VA ARM payments, it's advisable to consult with a qualified VA lender. They can help you estimate monthly payments accurately and better understand how your payments may fluctuate over time.