What Are VA ARMs And How Do They Work?

If you’re eligible based on your service to our country or you are an eligible surviving spouse, VA loans are among the best deals around, often requiring no down payment. With rising interest rates, the low initial rates for adjustable-rate mortgages (ARMs) can be a great advantage for active military members or others who may move or refinance soon. Let’s take a closer look at VA ARMS, how they work and their requirements to get approval. We’ll break down some of the pros and cons of getting one, too.

What Are VA ARM Loans?

VA ARM loans are adjustable-rate mortgages backed by the Department of Veterans Affairs (VA). ARMs have interest rates that adjust up or down with the market after a certain period. Structurally, VA ARM loans work the same as other ARMs in terms of handling adjustments.

How Do VA Adjustable-Rate Mortgages Work?

VA adjustable-rate mortgages are functionally the same as any other ARM. They remain at a fixed rate for a given period of time at the beginning of the loan. At the end of the fixed period, they adjust at given intervals. There are caps and floors that limit how much the rate can adjust up or down initially, on each subsequent adjustment and over the life of the loan.

When the rate adjusts, it does so based on an index. Whatever index is used is added to a margin and rounded to the nearest 0.125%.

In the case of VA loans, the index used for adjustments is the 1-year constant maturity treasury (CMT). Interest rates adjust up or down once per year after the fixed period on a date specified in your mortgage contract. Though not a hard rule, most ARMs are based on 30-year terms.

5/1 ARMs

If you’re looking into a VA ARM loan, you might see terms like “5-year ARM.” This refers to the period during which you’ll have a fixed interest rate before your mortgage lenders make any adjustments. In a 5-year ARM, the interest rate you get won’t change for the first 5 years after you close on your mortgage. After the initial 5-year period, your rate starts to fluctuate based on a fixed schedule. Let’s take a closer look at an example.

5/1 Adjustable-Rate Mortgage: Interest Rates And Caps

With a 5/1 ARM the initial interest rate is in place for 5 years. After that, your rate will change once a year. For each interest adjustment, you have a rate cap. That means your rate won’t go up or down more than a set percentage (usually 1%). Your interest rate will also have both a cap and floor for each subsequent adjustment.

There are also set limits on the lifetime adjustment for the loan. For example, your rate for the lifetime adjustment limit might be capped at 5% (this is the typical limit). This would mean that if you start with a 5% rate, your interest rate will never be higher than 10% during the life of the loan.

5/1 Adjustable Mortgage Rate Example

Let’s take a look at an example to get a better understanding of how a VA ARM might look in practice.

Say you take out a VA ARM with an introductory rate of 6%. Your payments will be consistent for the first 5 years of your loan. For the 6th year of your loan, you may pay up to an additional 1% in interest, bringing your interest rate up to 7%.

Depending on the market, this rate could be different. It may only adjust by 0.25%, bringing your rate to 6.25% or it could even go down (note that a floor will typically be in place to limit how much your rate can drop). Every year afterward, your mortgage will adjust once a year with the same cap rate limitation. Your set lifetime limit means there is a cap on your interest rate. If this limit were set at 5%, as is typical, your rate would never rise past 11%.

Getting An ARM Vs. A Fixed-Rate Mortgage

When might you choose an ARM over a fixed-rate mortgage? You should consider an ARM if you especially need a low initial rate and/or if you expect to be in and out of the home before your rate ever adjusts.

As interest rates rise, ARMs tend to have initial rates that are quite a bit lower than fixed rates. That means that for those first years of the ARM you’ll get a lower rate than you would on a comparable 30-year fixed mortgage. That’s because the rate can be adjusted and doesn’t require investors to try to project inflation over a long period of time.

If you plan to sell your home within a few years, you won’t need to worry about the rate adjustments at all. This is particularly helpful for military families on active duty who might need to move frequently.

The VA also gives lenders the option of providing loans with 1-, 3- and 5-year fixed-rate periods of the beginning of ARMs.

Who Is Eligible For A VA ARM?

In order to be eligible for a VA ARM, borrowers have to meet the service time requirements that would come with any VA home loan. The exceptions to this include veterans receiving VA disability due to a service injury and surviving spouses who receive dependency and indemnity compensation (DIC). The VA has a breakdown of minimum service time requirements.

 

Though the VA sets guidelines it does not set individual home loan requirements. You’ll also need to meet your mortgage lender’s requirements to qualify for a VA ARM.

What Requirements Do I Need To Qualify For A VA ARM?

There are several requirements for getting a VA loan. A couple of these are imposed by the VA itself, but the majority of this is left up to lenders.

Pros And Cons Of A VA Adjustable-Rate Mortgage

There are advantages and drawbacks to every loan option and the VA ARM is no different. Let’s take a look at some of the advantages and disadvantages of this loan type.

Pros Of A VA ARM

 

Cons Of A VA ARM

How Do I Apply For A VA ARM Loan?

When applying for a VA loan, there are many things you should expect to provide, most of which are common to any mortgage application. The exception is the COE. Here are some of the documents you should have on hand for when you start the mortgage process for a VA loan:

Your lender will also run a credit check and take a look at your credit report. They may request additional documentation during the application or underwriting process.

The Bottom Line

A VA loan offers a ton of benefits for those who have served our country. In a real estate market where interest rates are rising, a VA ARM may be more attractive due to its lower initial interest rates. VA ARMs come in a variety of fixed-rate lengths at the beginning of the loan, adjusting once per year afterward.