Mortgage rates are on the rise after years of record lows for modern-day homebuyers.
With rock-bottom rates in the rear view, some would-be buyers are taking a closer look at VA adjustable-rate mortgages.
ARMs came under fire in the wake of the Great Recession. They’ve also slipped more into the shadows with fixed interest rates so low for so long.
But VA ARMs can make financial sense for Veteran buyers in some cases.
The key is understanding the benefits and drawbacks of adjustable-rate loans, along with your own tolerance for uncertainty and risk.
Fixed-rate mortgages are grounded in certainty. The interest rate you start with never changes for the length of your loan term, whether it’s 10, 15 or 30 years. The means your principal and interest payments won’t change either.
Your full mortgage payments can and often do change every year, but that’s because of changes to your property taxes or homeowners insurance. Still, those aren’t typically major swings, which gives buyers a good deal of confidence in their monthly housing costs for the long term.
Adjustable-rate loans are exactly what they sound like. The interest rate can change, and how often depends on the type of ARM loan you get. But VA ARM rates are typically lower than fixed rate initially.
Traditional ARMs can adjust their rate after just one year. Hybrid ARMs have a fixed rate for a set number of years before they can adjust annually.
For VA loans, the government has what’s known as a 1/1/5 cap in place to help protect Veteran homebuyers. The cap means the rate can jump no more than 1 percentage point when it adjusts for the first time and in any year after, and that it can’t increase over 5 percentage points for the entire mortgage term.
For example, if you’re getting a 5/1 VA hybrid ARM with a 4% initial rate, the highest rate you can pay in Year 6 is 5%, and the rate can never exceed 9%.
With VA hybrid ARMs, one of the big questions is: What happens after five years?
The objective answer is that we don't know. It's possible that mortgage rates in five years could be the same as today, and it's also possible that they could be lower.
Some ARM homeowners might look to refinance when the time comes. Others might still be better off. It’s tough to say, and every buyer’s situation is different. Refinancing comes with its own costs and fees, and there’s no telling what market rates will be when the time comes.
Still, adjustable-rate loans can make sense for some buyers, especially with mortgage rates surging.
Having the lower initial rate with an ARM can help Veterans buy more house or just save money out of the gate.
For example, on a $300,000 home, the monthly principal and interest payment on a 30-year fixed loan with a 6% rate is $1,799. With a 5/1 VA hybrid ARM at 4%, that payment drops to $1,432, a difference of about $370 per month.
Another way to think about it: That additional $370 translates to an extra $75,000 in buying power in this example. The monthly payment on a $375,000 home with a 5/1 VA hybrid ARM at 4% is $1,790.
For some buyers, that savings is critical. For others, buying more house for roughly the same starting payment is a huge plus.
What’s important is understanding that those monthly housing costs could look much different in a few years’ time with an adjustable-rate loan. That doesn’t make them bad – just different, and something would-be buyers should consider with care.
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A VA loan is a mortgage option issued by private lenders and partially backed, or guaranteed, by the Department of Veterans Affairs. Here we look at how VA loans work and what most borrowers don’t know about the program.