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 at the start of the loan. At the end of the fixed period, they adjust at given intervals. There are caps and floors that limit the initial adjustment of the rate up or down, each subsequent adjustment and over the life of the loan.
When the rate adjusts, it does so based on an index. Whichever index is used, it is added with a margin and rounded to the nearest 0.125%.
In the case of PV loans, the index used for adjustments is the 1-year Constant Maturity Treasury (CMT). Interest rates adjust up or down once a year after the fixed period on a date specified in your mortgage agreement.
They don’t have to be, but most MRAs are based on 30-year terms. When you see something like “5-year ARM”, it refers to the period of time you will have a fixed interest rate before any adjustments. Let’s go into an example of how this works. Say you saw an advertisement for an ARM 5/1 with capital letters 1/1/5. Your initial interest rate is 5% with a margin of 2%.
First, the 5/1. This means that the rate remains fixed for the first 5 years of your mandate and adjusts once a year thereafter. Now the caps. The first 1 is the initial ceiling. During the initial adjustment, your rate will not go up or down by more than 1%. The second 1 is the ceiling and floor for each subsequent adjustment. The final number is the lifetime adjustment limit. Your rate won’t go up or down more than 5% as long as you have the loan.
Depending on the difference between current market rates and your original interest rate, the floor may not come into play due to the spread. In this case, your rate will never be less than 2%. But it also helps limit the high end of rate adjustments.
When might you choose an ARM over a fixed rate mortgage? There are two situations to think about. First, if you expect to get in and out of the house before your rate adjusts, you’ll get a lower rate than you would get on a comparable 30-year fixed rate because the rate can be adjusted and n does not require investors to try to project inflation over a long period.
Second, as interest rates rise, ARMs tend to have rates that seem a bit lower than fixed rates. It has to do with a complicated investment concept known as the yield spread premium. We don’t need to dwell on it here. Just be aware that as rates go up, ARMs look better.
Rocket Mortgage® offers 5-year VA ARMs. The VA also gives lenders the ability to provide loans with fixed rate periods of 1, 3 and 5 years from the start of the ARM.