How Does a VA Adjustable-Rate Mortgage Loan Work?

Marcus Marion, CMA™ 9 months ago 0 11

VA loans allow eligible borrowers to buy a house with no down payment. Adjustable-rate mortgage loans, or ARMs, often provide a lower initial interest rate. Put the two together and you have a way to finance 100% of the purchase price while securing a lower mortgage rate.

This article is part of a broader series that examines every aspect of the VA home loan program and the unique benefits it provides. In previous articles, we’ve explored everything from the basic income requirements for this program to the final closing process.

Today, we will explore the unique features and potential benefits of a VA adjustable-rate mortgage loan, and when it might make sense to use one.

Breaking Down the Terminology

Let’s start by covering the two most important terms that will be used throughout this article. As a borrower, it’s important to understand the mortgage terminology and concepts that can affect you when using a VA home loan.

A VA loan is a type of government-backed mortgage loan available to military members, veterans, and qualifying spouses. Mortgage lenders who offer these loans receive a guarantee from the federal government, which reduces the potential risk associated with borrower default. VA loans offer many benefits including zero down payment, flexible qualification criteria, and the ability to avoid mortgage insurance.

An adjustable-rate mortgage (ARM) loan is a type of home loan where the interest rate can vary over time based on certain market conditions. Typically, ARMs have an initial fixed-rate period, during which the interest rate remains constant. After that initial phase, however, the mortgage rate can change on an annual basis.

By contrast, a fixed-rate mortgage loan is one that has the same interest rate for the entire life of the loan, even if the borrower keeps it for 30 years.

VA Loans Can Have A Fixed or Adjustable Interest Rate

You have some options when it comes to the structure of a VA home loan. For one thing, you can choose whether you want it to have a fixed or adjustable interest rate. There are pros and cons on both sides of the equation, and we’ll cover them in a moment.

According to the VA Home Loan Guaranty Buyers Guide, a publication created by the U.S. Department of Veterans Affairs: “VA loans can be a fixed-rate or adjustable rate mortgage (ARM).”

The guide goes on to state that the fixed-rate mortgage version is “the most common VA loan option” among borrowers. The reason for its popularity has to do with stability and predictability.

The “fixed-rate” mortgage gets its name because it has a set principal and interest payment throughout the life of the loan, no matter how much interest rates might change nationally. (But it’s possible for homeowners to see a slight increase in their monthly payments over time, due to changes in local property taxes and/or insurance.)

Most borrowers who use a VA loan choose the fixed-rate mortgage option for this very reason. They like the idea that the interest rate will never change no matter how long they keep the loan, even if market rates rise significantly during that timeframe.

But there are scenarios where it might make more sense to use a VA adjustable-rate mortgage loan when buying a house.  As the VA’s home buyer guide explains: “These loans may have a low introductory rate, but the rate can grow over time and so will your monthly mortgage payment.”

So let’s explore some of the scenarios where it might make more sense to use an adjustable-rate VA loan, compared to the more popular fixed mortgage option.

When to Consider Using a VA ARM Loan

When choosing between a fixed or adjustable-rate VA mortgage loan, think about your long-term housing plans and financial priorities. These considerations will help you choose the best financing option based on your unique situation.

As mentioned above, ARM loans offer the advantage of a low introductory interest rate. The introductory or initial period could last anywhere from one to seven years, depending on the type of loan you select.

For example, a “5-year ARM loan” has a fixed interest rate that does not change for the first five years. After those first five years, the mortgage rate will begin to adjust on an annual basis. And it might adjust upward or downward, depending on market conditions. That’s the uncertainty factor we talked about earlier.

But in certain scenarios, a home buyer could use an adjustable-rate VA loan to secure a lower rate while avoiding this long-term uncertainty. The borrower gets the “best of both worlds.” They secure a lower mortgage rate and a smaller monthly payment during the first few years, but avoid the possibility of a rate hike down the road.

Here are some scenarios where it might make sense to use a VA ARM loan:

  • Buying a starter home. Adjustable-rate mortgages often have lower introductory interest rates than fixed-rate mortgages. This can make the VA ARM loan a good option for borrowers who are buying a starter home and need to keep their monthly payments as low as possible.
  • Planning to refinance. If a borrower plans to refinance their mortgage within a few years, it might make sense to use an ARM. The borrower could take advantage of the low introductory interest rate, and then refinance to a fixed mortgage before the interest rate adjusts.
  • A relatively short stay. If a borrower knows that they will only be living in the home for a few years, an adjustable-rate VA loan might make a lot of sense. Borrowers are less likely to be affected by interest rate increases if they plan to sell the home before the introductory period ends.

In all of these examples, the basic goal is the same. The borrower uses a VA ARM loan instead of a fixed-rate mortgage to secure a lower interest rate and smaller monthly payments. They enjoy that lower rate for the first few years of homeownership, and then either sell or refinance to avoid the adjustments. That’s the most common strategy when using an adjustable mortgage.

Think about your priorities and your long-term housing plans. What’s more important to you, the long-term stability of a fixed mortgage, or the short-term savings associated with an ARM loan? This kind of soul searching will help you choose the best option for your particular situation.

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