VA Adjustable-Rate Mortgages (ARMs)

Navigating the mortgage landscape can be complex, especially when comparing different loan structures within the same program. VA loans, for example, offer both fixed-rate and adjustable-rate options, each with distinct benefits and risks.

This article explores VA adjustable-rate mortgages (ARMs), including how they work, how they differ from fixed-rate loans and when they may make sense for your financial situation.

What Is a VA Adjustable-Rate Mortgage (ARM)?

A VA adjustable-rate mortgage (ARM) is a type of VA loan where the interest rate can change over time after an initial fixed-rate period. Unlike a fixed-rate mortgage, which keeps the same interest rate for the life of the loan, a VA ARM typically starts with a lower introductory rate that adjusts later based on market conditions.

Most VA ARMs are structured as hybrid ARMs, meaning they have a fixed rate for a set number of years before transitioning to annual adjustments. Common options include 5/1, 7/1 and 10/1 ARMs. These loans usually amortize over 15 or 30 years.

To qualify for a VA ARM, borrowers must meet standard VA eligibility requirements, including qualifying military service (or an eligible relationship), along with lender-specific credit, income and debt-to-income (DTI) guidelines.

What Is the Difference Between a VA ARM and a Fixed-Rate Mortgage?

A VA adjustable-rate mortgage (ARM) and a fixed-rate mortgage differ in how the interest rate and monthly payment can change over time.

A fixed-rate mortgage keeps the same interest rate for the life of the loan, which keeps your monthly principal and interest payment predictable. A VA ARM, on the other hand, starts with a lower fixed rate for a set period before adjusting annually based on market conditions.

Compared to a VA ARM, a fixed-rate loan typically starts with a higher interest rate but offers long-term payment stability.

How VA ARMs Work

VA ARMs are named based on their structure. The first number represents the number of years the interest rate remains fixed, while the second number indicates how often the rate adjusts after that period.

For example, with a 5/1 ARM, the interest rate stays fixed for the first five years and then adjusts once per year after that.

After the fixed period ends, the new interest rate is determined by adding a margin (set by the lender) to a benchmark index rate that reflects broader market conditions. This means your rate can rise or fall depending on how the market changes. Because of this, your monthly payment can also change over time.

VA ARMs include built-in protections known as rate caps, which limit how much your interest rate can increase:

• Initial adjustment cap: Your rate can increase by no more than 1 percentage point after the fixed period ends
• Subsequent adjustment cap: Each future annual adjustment is limited to 1 percentage point
• Lifetime cap: Your rate can increase by no more than 5 percentage points total over the life of the loan

For example, if you start with a 6.75% rate on a 5/1 ARM, your rate could increase to 7.75% in year six, 8.75% in year seven and continue rising gradually, but it would never exceed 11.75% over the life of the loan. These caps set maximum limits, but actual adjustments depend on market conditions and may be smaller.

VA ARM Considerations

A VA ARM can be a good choice for some, but not everyone. The main users of ARMs typically include borrowers who don’t plan to stay in the home very long or those looking to buy in a turbulent rate environment. 

Borrowers who know they won’t be in a home for more than a few years can reap the interest rate savings typically found with ARMs. Even a quarter percent in savings over five years adds up.

For example, a first-time homebuyer purchasing a $250,000 home with $0 down at a 6% rate will pay $107,919 in the first five years of the loan. Conversely, a borrower with a 5.75% rate will pay $105,043 – nearly a $3,000 difference.

The second group that typically looks into VA ARMs are those shopping in an unpredictable rate environment. When rates jump, borrowers can attempt to save money with a lower interest rate upfront with hopes of rates stabilizing and coming back down.

There’s no guarantee, so these borrowers are taking a gamble. VA loan interest rates may be the same in 3-5 years or significantly higher.

What Are the Downsides of a VA ARM?

Even with the 1/1/5 cap, VA ARMs come with risks. The largest downsides to VA ARMs include the following:

1. Uncertainty: Since the interest rate on an ARM can change over time, your monthly mortgage payments can increase or decrease. This uncertainty can make it difficult to budget and plan for future expenses.
2. Payment shock: If interest rates rise significantly, your monthly payments can increase substantially, leading to “payment shock.” Payment shock can put financial strain on borrowers who didn’t prepare for higher payments.
3. Complexity: ARMs can be more complex than fixed-rate mortgages, with various adjustment periods, rate caps, and indexes. It’s essential to fully understand the terms and conditions of your ARM to avoid potential pitfalls.
4. Refinancing risk: Borrowers who plan to refinance their ARM to a fixed-rate mortgage may face challenges if interest rates rise, making the new loan more expensive. Additionally, declining home values or changes in personal financial circumstances can make refinancing difficult.

Final Thoughts

VA ARMs, as with any ARM product, can be complex. You need to understand what you’re getting into and whether you can handle the risk. If you’re interested in learning more about VA ARMs, contact a VA lender who can help guide you through the process and crunch the numbers. After seeing how an ARM fits your unique financial situation, you may feel the savings are validated or not worth the risk.

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