Most veterans I speak with are wary when it comes to the subject of adjustable rate mortgages, or ARMS. The perception is that at best they are uncertain, and at worst, they are disastrous. Many veterans I work with are on fixed incomes and can’t afford any more uncertainty in their lives, particularly when they are already battling to keep their credit cards at bay. Other veterans tell me that their goal is to simply pay off their home as quickly as possible, and that an ARM could potentially undermine this effort. Its hard to argue with this logic. For many, ARMs equal uncertainty. And having worked with many homeowners over the years, I would venture to say that veterans crave security more than most; a fact made even more apparent to me during a VA mortgage seminar my office held for some area veterans.
I began the meeting with a simple question: What do you know about adjustable rate mortgages? To my surprise, the veterans responded immediately.
“They lure you in with low rates, and as soon as you sign the paperwork your loan starts to adjust out of control.” one veteran warned.
“I heard that your rate is fixed for a short time, but after that the bank can raise your rate whenever they want to.” another interjected.
“Adjustable Rate Mortgages are the reason that we are in this banking crisis to begin with.” noted another.
“If you miss a payment the bank has the right to take your first born child.” cautioned a fourth.
Okay, the last one was made up, but you get the idea. I suppose what I found most intriguing about the question was that there was no shortage of responses and they were almost universally negative. Being that I was there to discuss the new VA Hybrid ARM product, I felt the best, most relatable approach would be to describe a recent experience with a fellow veteran who had opted for this product.
I recently took an application for a veteran named Colonel Mustard. I’ve changed his last name of course, but I can assure you all that this man was, in fact, a “full bird” colonel. I mention this because right from the get-go he let me know how the call was going to play out: He told me that he would only provide enough information to send him a loan quote for a VA 30 year fixed rate mortgage. Once I did he would compare my offer against several others, and if I was the best, he would call me. I took his application, prepared a Good Faith Estimate and sent it to him. As always, I explained to him that rates were date sensitive and were subject to change due to market conditions.
Although Colonel Mustard acknowledged this, he must have forgotten it immediately because two weeks later I received a phone call from him followed by a signed copy of the estimate.
“James,” he said, “I’ve weighed the options and compared your quote to all the other ones I’ve received. Yours was the best. I’m ready to lock in my rate today.”
“I appreciate your business Colonel, but I’m unable to lock in the rate that I quoted you.” I apologized. “You might remember sir, that I told you the rate would only be good for 24 hrs. The market ultimately determines rate movement. Unfortunately, the market has pushed the rates higher since we last spoke. However, you might be interested in the VA Hybrid ARM as an alternative. In fact, given your desires to pay your home off faster I think this would be a better fit.”
“I told you I’m not interested in ARM’s.” he said flatly, and proceeded to list the same objections raised earlier.
“While I understand your objections sir, not all ARM’s are created equal. The Hybrid Arm is a VA insured loan. It is entirely different than those you are describing. Consider the following:
- The VA Hybrid loan does NOT adjust to whatever the bank wants to set it at. It moves in accordance with the rates of the US 1 yr Constant Maturity Treasury index. Below is a graph reflecting the performance of the treasury index over the last 10 yrs. You will see that the rate never moved higher than 6.33% . The average rate over this 10 year period was around 3%. In all this time, the index has never moved more than 1% in a year, and never in consecutive years.
- You will enjoy a fixed rate of 3.75% for 60 months saving twice as much as the fixed rate option.
- With the additional savings you can have all of your non-mortgage debt (credit cards, etc) paid off much faster, freeing up additional $ in monthly expenses. These additional dollars can be leveraged into even greater principal reduction.
- Your rate can never adjust more than 1% a year, regardless of what the index rate is.
- Your rate does not automatically adjust up, it can just as easily adjust downward depending on the market
- If your rate ever does adjust the loan will reset the payment based on the remaining balance. By contrast, the payment on a 30 fixed rate loan is based off the loan amount at the time the refinance closes and will never change. If you were to make the same payment on the VA Hybrid ARM as you would have made on the 30 year fixed option, the difference would be deducted from the balance each month. By doing this, you could possibly have a lower payment, regardless of what the rate might adjust to. (see VA 30yr Fixed Rate vs. VA Hybrid ARM comparison below.)
- You will be able to obtain this rate for significantly less fees than the fixed rate
|1 Year Constant Maturity Treasury Rate|
Source: Federal Reserve Board
VA HYBRID ARM vs. FIXED RATE OPTION
$300,000 VA 30yr Fixed Rate Loan at 4.75%
- Monthly Mortgage Payment = $1564.94
- Loan Balance after 5 years = $274,494.89
- Mortgage Payment after 5 years = $1564.94 (payment never changes on a 30yr fixed loan)
- Loan Balance after 6 years = $268,627.47
$300,000 VA Hybrid Loan at 3.75% making the 30 year fixed payment
- Monthly Mortgage Payment = $1389.35 OR $175.59
- Loan Balance after 5 years = $258,663.72 OR $15,831.17 lower than 30yr Option
- “Worst Case” payment after first adjustment if rate adjusts to 4.75% = $1482.06 OR $82.88 lower than 30 yr option at the same rate
After covering these options in detail, there was a long pause on the phone. Finally, Colonel Mustard spoke, “So you’re telling me that for the next 5 years, I’m guaranteed to save $175 more per month that the other option, which isn’t even available?”
“Yes.” I replied.
“Is there a penalty for paying extra toward my principal balance?” he asked.
“Like all VA loans, there are no prepayment penalties or balloon payments on this product. You are free to put as much as you like toward the balance as you like. The Fair and Accurate Credit Transactions Act stipulates that any amount that you add to your payment above the required amount must be deducted from the principal balance. Is that what you are planning to do?”
“Well yes, but on the other hand I’d rather use the money at first to pay off some credit cards and a pool loan. Would that put me at a disadvantage with the loan?” he asked.
“Not necessarily. In fact doing so will likely be even more beneficial to you. Most people tend to see their mortgage payments as separate from their finances. The idea is to prioritize paying off your debt in order of the debts with the highest rates first, as opposed to the highest balances first. How much non mortgage debt do you have that is at a higher rate than your VA mortgage?” I asked.
“Let’s call it around $15,000, for which I pay $400 a month.”
“Even better. If you were to apply the monthly savings of $175 per month to this debt you would likely have it all payed off in just under 3 years. By this time, you will have freed up $575 a month which you will enjoy for at least 2 years, guaranteed. Remember, its all about the lowest monthly expenses. If the VA Hybrid ARM lets you achieve this faster than the VA 30 year fixed loan then I think the answer is clear.”
“Okay. One last question. What if things change and I want to fix the interest rate?” he asked.
“Low VA Rates offers a no-cost refinance for any return customer veteran wishing to refinance out of the Hybrid ARM. Again, there would be no prepayment penalties associated with this. Like the VA 30 year fixed option, you would still be eligible to defer two months payments and receive an escrow refund.”
An even longer silence. But after what seemed like 2 minutes, Colonel Mustard spoke:
“Send me the paperwork. This sounds good to me. I appreciate your help.” he said.
“Happy to help, sir. I will send that to you right away. I would be happy to lock you in as soon as you send the signed disclosures back to me.”
“Sure thing. I should have it to you in the next couple of weeks.” He said dryly.
“Just kidding , James.” he laughed.
“Right. Good one, sir. Thanks a lot.”
Flash forward back to the seminar. I had just finished recounting the Colonel Mustard story and the room was quiet. I could tell that many of the veterans were deep in thought. I decided to break the ice. “Listen folks, what you should take away from this is that, like loans, not all ARMS are created equal. Colonel Mustard happened to discover that the VA Hybrid ARM was the program that best fit his goals. For those of you with stable income and a decent amount of debt, this might be a dream come true. For others, a traditional fixed rate loan will be more beneficial. At the end of the day it depends on the individual’s financial circumstances and goals. But ask yourselves, if there are 30 year fixed conventional mortgages, yet you all still favor the VA 30 year fixed mortgage, doesn’t the VA Hybrid ARM deserve a second look apart from conventional ARMS?”
Oddly, this didn’t seem to break the silence. However, just when I was begining to squirm, the questions started flying. By the end of the seminar, four of the veterans had asked me to price out refinance options for them on the Hybrid ARM.
We all know that most active duty military personell live transient lives, being forced to relocate and move at every transfer. Similarly, veterans, as well as the rest of the private sector are finding more and more that they are living in a transient society. Americans move on average every 5 years (increasingly out of state) in search of work. Furthermore, the vast majority of veteran homeowners simply do not stay in their homes for a 30 year term. If we can accept this as true, then I believe that the VA Hybrid ARM deserves to be considered whenever a veteran is looking to refinance. It won’t work for everyone, but it will work best for many.