Common Myths about VA Hybrid ARMs Debunked Part 2
This is the second of two articles about common myths about VA hybrid ARMs. For more information on these myths and an interesting presentation, check out our video on YouTube. The first two myths were covered in the first article; these are the last two, starting with number three.
3. If I want to pay my house off faster, then I should use a fixed rate on a shorter term.
Again, this is not true. The reason is simple. Your ability to pay off your home faster than the minimum is based on basically two things: the minimum payment, and your income. Since your income is probably independent of the choice between a fixed-rate or a hybrid ARM, the only thing that changes is the minimum payment. Your minimum monthly payment is primarily principal+interest. If you are at a lower interest rate, your minimum payment will be lower as well.
In the above example, where the fixed-rate is at 4.5% and the hybrid ARM is at 2.25% for the first three years, the hybrid ARM will have a significantly lower minimum payment than the fixed. What does that allow you to do? Pay more than the minimum payment! Just by paying the amount you would have paid (or have been paying) on the 4.5% fixed-rate, you can pay off more principal faster on a hybrid ARM. Plus, since it is extremely unlikely that interest rates will go up consistently for seven years in a row, you could be 10 years into the loan before your hybrid ARM rate gets as high as the fixed-rate was at the beginning! By then, if you’ve paying what you would have paid on a 4.5% fixed-rate, you may only have 5 or 10 years worth of payments left, and far less principal to be charged interest on than you would have otherwise.
4. A 30-year fixed rate is safer and better for someone to forecast or plan for the future.
This is a myth that is present mostly here in the United States. It is no coincidence that the U.S. was also hit the hardest by the housing crisis. This myth is devastating because of the simple fact that nobody is ever really paying off the same loan over 30 years – by far (like 99%), most people who purchase homes get a new loan every 4-6 years. This is why the VA offers both 3-year and 5-year hybrid ARMs, whose rates remain fixed at a much lower rate during the initial period – until about the time most borrowers are going to be refinancing or selling anyway. But even for those very few who keep the same loan beyond 6 years, the VA has built in protections to make sure that those borrowers aren’t hit too hard by changing interest rates.
First, as mentioned above, the VA uses the CMT index, which is a fairly gentle and non-volatile index, to calculate its rates. The CMT index prevents volatility by averaging activity over 12 months to calculate a yearly average. This yearly average is what is used as the index on VA hybrid ARM loans. Second, the VA places an annual cap that prevents interest rates from rising by more than one percentage point each year. Also mentioned above, this limitation means that even if interest rates are skyrocketing, it could still take years to get as high or exceed the interest rate you’d be dealing with on a fixed-rate mortgage. Third, the VA loan program puts a ceiling on how high the interest rate can ever go. If your hybrid ARM started at 2.1% after the initial fixed period, it could never go higher than 7.1% no matter what interest rates are doing. This is an extremely valuable protection not only for the money it saves in case interest rates do skyrocket and stay there for an extended period of time, but also so you can forecast and plan for the worst-case scenario. You can know with 100% surety what you are risking with a hybrid ARM.
As a bonus for those who are still not convinced, think of what you can do with all the saved money from a lower interest rate. Imagine taking the money that you would have been spending on a higher monthly payment with a fixed-rate mortgage and paying off your credit card debt. Credit cards can have interest rates in the 20% area – especially for delinquent amounts. Taking money saved with a lower mortgage payment and using it to pay off credit cards can save you a ton of money in both the short-run and the long-run.