In a previous blog post, I discussed the benefits offered by the VA Hybrid Loan programs. By now, more veterans than ever before are finding that the VA Hybrid Loans are not only more secure than they had previously assumed, but they offer a more efficient vehicle to achieve their financial goals. This post will expound one of the most beneficial and widely cited benefits of the VA Hybrid loan – debt management and reduction.
There are three guiding principles associated with debt management:
· Evaluating and organizing debts by interest rates, terms and payments.
· Consolidating higher interest rate debt into lower interest rate debt
· Prudent Building and redirecting cash flow to pay off debts.
Let’s begin by recapping the feature benefits of the VA Hybrid loan program.
· ARM’s have a smaller fixed rate term (ex. 3-5yrs) but enjoy lower rates during that time in comparison to a fixed rate loan option. On average, rates on Hybrid VA loans are greater than 1% lower when compared to VA fixed rate loans.
· Hybrid ARM loans feature favorable terms unique among adjustable rate mortgages that include 1% yearly and 5% lifetime rate caps. Unlike most ARM loans which adjust monthly after the initial fixed rate period has elapsed, Hybrid ARM loans adjust once per YEAR and are tied to a financial index (1yr Monthly CMT) that averages rate changes over a 12 month period so as not to subject the borrower to wild payment swings.
Depending on specific debt picture, these favorable terms help VA Hybrid ARMS free up more money faster than traditional ARMs. Why? While it’s true VA Fixed Mortgage Rates don’t change, neither does the payment. In a debt reduction analysis, payments that do not adjust downward as one pays the balance are generally of a lower payoff priority than ones that do. For example, credit card interest is usually much higher than that of a mortgage, to say nothing of the fact that mortgage interest is more easily tax deductible than credit card interest. But even in cases where the borrower is enjoying a low introductory rate on a credit card, one that may even be lower than the mortgage, the more money the borrower commits to the credit card, the smaller the payment obligation will be the following month. The smaller the payment obligation the more quickly the additional savings can be applied to remaining debts. In this way, we can see that saving money in the short term often trumps long term loan benefits and provides an easier path to a debt free life.
Many VA homeowners who have followed these principles find themselves free of non-mortgage debt but later faced with an entirely distinct (albeit less serious) condition: Where is the best place to park the monthly savings now that other debts are clear? This problem is especially profound when dealing with active duty military personnel or reservists who are transferred or move to a new station. For those veterans unsure about how long they will live in a home, the hybrid arm allows the flexibility to build cash reserves. Until they move, they are free to put the payment savings into interest bearing accounts which maximize the dollars saved by the loan. Best of all if they ever “need” the money they can access it from their account at any time, without having to sell the home or to do a cash-out refinance – both instances where the veteran borrower would have to incur a closing cost or transactional fee in order to access money that could have stayed in their possession. The traditional alternative has always been putting additional savings toward the principal balance, which, while psychologically comforting does not offset the risks of devaluation or the security of being able to retain more money each month. Imagine if after 10 years you had paid your $200,000 mortgages down to a balance $100,000. If the value had not changed in that time, you could say that you have $100,000 in EQUITY. But in all that time the payment would still be the same dollar amount as it was when the loan was originally closed. But there are other disadvantages. Consider if the value of the home dropped from $200,000 to $90,000. You would be unable to access all the money you sacrificed to bring down your balance. You may have had the intention to build your equity in this way to make sure you had more money when you eventually sold the home. In this example, it would be gone since equity isn’t real money to begin with. I’ve worked with many veterans who have championed this strategy, particularly in a real estate market as nebulous as this one. Some were able to stave off an unexpected period of unemployment, others were able to sell their homes and come to the table with a portion of their saved reserves to complete the transaction and avoid a credit-damaging short sale.
Whatever the case may be, there are an abundance of options afforded to the savvy veteran homeowner by the VA Hybrid Loan program. This program is less about simply having a lower rate, it’s about having a greater degree of flexibility with your own money. Do the math. Banks are crafty enough to know that over the course of a 30-year loan you will have paid back the principle balance borrowed twice in interest. They structure loans so that you pay the maximum interest in the early years. They do this because they know that most people sell their homes or refinance the mortgages well before 30 years. It’s not my intent to cast a dark cloud over lenders. I’m not a rich man. Most people aren’t. The opportunity to finance a house is a good thing. Most of us are willing to accept a certain amount of economic disproportion in order to live in a house with our families. All any of us can do in response is to look past the myth that 30yr fixed mortgages are the only vehicle toward financial promise. We may find that the Hybrid isn’t for us, but at least we will know if we are making the most of the options at our disposal. I can promise you all that the banks most certainly will.