What is a VA Hybrid ARM?
This is a great question, and it touches on one of the coolest options you have when you’re looking into getting a VA loan. To explain what a Hybrid ARM is, we’re going to work from the ground up to make sure we’re all clear on the terms that we need to know before we can understand what a Hybrid ARM is. First, we’ll cover the different types of interest rates you can choose and what they mean. Then we’ll go into how a hybrid ARM works. Last, we’ll explain why hybrid ARMs can actually save borrowers a big chunk of change most of the time even though most people have a negative impression of ARM loans and hybrid ARMs.
So, when you’re getting a VA loan, you can choose to get a fixed-rate mortgage, an adjustable-rate mortgage (ARM), or a hybrid adjustable-rate mortgage (hybrid ARM). The names give fairly accurate definitions themselves, but we’ll cover them each specifically. A fixed-rate mortgage is where you get locked into a rate at the time of application, and that rate stays the same for the life of the loan regardless of what the market does. An adjustable-rate mortgage is a type of interest rate that adjusts with the market. Lenders will generally offer lower interest rates on an ARM and as they fluctuate they will generally be slightly lower than what fixed-rate borrowers are being offered at the time. A hybrid ARM is a loan type that remains fixed for a certain number of years (usually 3-5) and then begins to adjust annually after that.
You may have heard the phrase, “the devil is in the details”. In this case, it’s the angel that’s in the details because it is the details that make the hybrid ARM such an awesome option. A VA hybrid ARM starts out with a fixed rate, often called a “note rate”. Right now, Low VA Rates is offering two note rates: 2.25% and 1.75%. That rate stays the same for 3-5 years. After the fixed period is over, the note rate is scrapped and your new rate is calculated by adding together the margin the lender offers and the CMT index. Low VA Rates is currently offering a 2% margin if the borrower takes the 2.25% note rate, and the CMT index is currently at .13%. So a borrower who is finishing their 3-year fixed period around now will go from their 2.25% note rate to a 2.13% interest rate for the next year. You are reading that correctly – their rate will actually drop. Are you ready for some more angelic details?
VA Hybrid ARMs can only adjust once per year and they cannot adjust by more than 1% each year. Over the life of the loan, the interest rate cannot rise more than 5% from where it started. So in the above example, at a starting rate of 2.13%, that borrower can never have an interest rate higher than 7.13%, and it would take a minimum of 5 years to do so. So, to be clear, for the first three years, you could be at 2.25% (conventional loans for people with good credit are hanging out at around 4.5% right now), then for the fourth year, your rate would drop to 2.13%, then even if the market shoots up and your rate really does rise a full 1% each year, in the 5th year it would be at 3.13%, in the 6th year 4.13%, and only in the 7th year would you finally be paying more (and not that much more) as a person in a fixed-rate mortgage has been paying for the past 6 years. By that time, you’ve saved a bundle of money and have gotten through the years in which you would normally be paying the most interest with a hefty discount.
Since monthly payments are so much lower on a hybrid ARM for at least the first 5 years, and likely longer, many borrowers pay the same amount that they would have paid on a fixed-rate mortgage, which means they end up paying off a chunk of extra principal each month. This has two effects: you pay off your loan much faster, and you pay a lot less in interest. For more information on what a hybrid ARM is, you can check out the short ebook here on our website, or you can contact us via phone or chat!