Deciphering the VA Lender’s Handbook Chapter 7 Part 13
The last two articles discussed in-depth about supplemental VA loans, how they work, what they can be used for, and how to get one. Chapter 7 of the VA lender’s handbook is dedicated to covering all of the different loan types that require special underwriting considerations in the VA loan program. There is a small section of this chapter that talks about the special considerations when processing a loan application for an ARM. This article will cover everything that the Handbook says about ARMs in this chapter.
Adjustable Rate Mortgages (ARMs) in the VA loan program are actually a very recent development. Only in 2012, as part of the Honoring America’s Veterans and Caring for Camp Lejeune Families Act, did the VA’s authority to guarantee ARMs and Hybrid ARMs become permanent. An ARM is an alternative to a fixed-rate mortgage. ARMs offer lower starting interest rates in exchange for the right to be annually adjusted to keep pace with wherever the market interest rates are at the time. For a traditional ARM, the annual adjustment begins after 1 year, but for Hybrid ARMs, there is an initial fixed-rate period between 3-10 years before the interest rate begins to adjust.
There are some differences in the way the interest rate is adjusted depending on whether you’re using a traditional ARM or a Hybrid ARM. For a traditional VA ARM, the annual interest rate adjustment is limited to one percentage point in either direction (e.g. a 4% interest rate cannot go higher than 5% or lower than 3% in a single year). As a further protection against the future, the rate cannot increase more than five percentage points over the life of the loan (e.g. a rate that starts at 4% can never become higher than 9%). Hybrid ARMs are a bit different.
For a hybrid ARM, the interest rate adjustments depend on how long the initial fixed-rate period is. If the initial fixed-rate period is less than 5 years, then the interest rate can only be adjusted a maximum of one percentage point in either direction for the initial adjustment, and can be adjusted by no more than two percentage points in either direction each year, with a cap of five percentage points over the life of the loan. If the fixed period is 5 years or longer, the initial adjustment, as well as subsequent annual adjustments, are limited to two percentage points, with a lifetime cap of six percentage points instead of five.
ARMs can be very advantageous, or they can end up being a worse deal than a fixed-rate. If interest rates go up during the life of your loan, a fixed-rate would have kept you at that lower rate, but if interest rates go down, then a fixed-rate would have to be refinanced (costing thousands of dollars in closing costs), in order to take advantage of the lower rates. As of the writing of this article, interest rates are still at near-historic lows, so really the only way interest rates can go is up. In a market like this, an ARM may not be the best option. Do not construe the above as investing advice or a professional consultation – consult with a VA-approved lender to make the best decision for you and your situation.
When an ARM is underwritten (and, therefore, approved), it is usually done so using an interest rate that is one percentage point higher than the starting rate. Why? Because over the course of a 30-year mortgage, it’s virtually guaranteed that the rate will get at least that high at some point. Since the interest rate dramatically affects your monthly payment, especially at the beginning of the loan, the VA requires that due diligence is done in making sure that the borrower is qualified for the higher rates that may come about later in the loan. If a hybrid ARM is being underwritten, it can usually be underwritten at the starting interest rate because it becomes very difficult to predict what interest rates are going to do more than three years out. If you’re interested in applying for an ARM, get with a VA-approved lender.