VA Adjustable-Rate Mortgages (ARMs)

Navigating the mortgage landscape can be complex, particularly when distinguishing between the various loan options available. Even individual programs, such as the VA loan, have loan types within them that have varying requirements.

This article explores a type of VA loan known as a VA adjustable-rate mortgage (ARM). We’ll explain the intricacies of the VA adjustable-rate mortgages (ARMs), VA hybrid ARMs and the use cases between these and fixed-rate mortgages.

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 after a certain timeframe. Unlike a fixed-rate mortgage, which maintains the same interest rate, an ARM starts with a typically lower interest rate that changes in the future based on market conditions. VA ARMs typically amortize over 15 or 30 years.

To qualify for a VA ARM, applicants must meet the VA’s eligibility requirements, which include military service or a qualifying relationship to a service member, and meet credit and income guidelines established by the lender.

How VA ARMs Work

Common types of VA ARMs include 3/1, 5/1 and 7/1 ARMs. The first number represents the number of years with the initial fixed rate. The second number means how often the rate adjusts annually.

For example, a veteran with a 5/1 ARM who closes on their mortgage at 6.75% will pay 6.75% for the first five years. After five years, the rate adjusts annually based on the market rate or index rate.

With VA loans and other government-backed mortgage products, VA ARMs adhere to a government-ordered 1/1/5 cap. The 1/1/5 cap means a lender can’t adjust your rate more than 1% on the first adjustment, each additional adjustment can’t exceed 1% and the rate can’t increase more than 5% over the life of the loan.

Let’s go back to the above example. The veteran with a 5/1 ARM and 6.75% rate will maintain that 6.75% rate for the first five years. In year six, the lender can adjust the rate up to 1 percentage point, bringing the rate to 7.75%. A year later, they can adjust another point, bringing the borrower to 8.75%. Say the rate continues to increase a percent each year. The borrower would hit the 5% cap in year 10 with a maximum mortgage rate of 11.75%.

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, as they’ve been in 2023, soar to recent highs, 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.

VA ARM FAQs

What is the difference between a traditional ARM and a fixed-rate mortgage?

An adjustable-rate mortgage (ARM) and a fixed-rate mortgage are home loans with different interest rate structures. Fixed-rate mortgages maintain the same interest rate for the life of the loan, while ARM rates can vary after a set time. Those who want predictable payments and plan to stay in their home for a long time often prefer fixed-rate mortgages.

What is the downside 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.

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.