What is a VA adjustable-rate mortgage?
This article is for educational purposes only. JPMorgan Chase Bank, N.A., does not offer a U.S. Department of Veterans Affairs (VA) adjustable-rate mortgage (ARM). Any information described in this article may vary by lender.
Quick insights
- A VA adjustable-rate mortgage (ARM) is simply an ARM backed by the U.S. Department of Veterans Affairs (VA).
- ARMs allow you to negotiate a fixed interest rate at the beginning of the loan. After the introductory period ends, there will be periodic adjustments to the interest rate over time.
- Interest rates can increase or decrease based on market conditions, but there are limits to how much they can change based on the type of ARM.
The Honoring America’s Veterans and Caring for Camp Lejeune Families Act of 2012 granted the VA permanent authority to guarantee adjustable-rate mortgages (ARMs). ARMs are mortgage loans with variable interest rates. A VA adjustable-rate mortgage is an ARM backed by the VA.
How does a VA adjustable-rate mortgage work?
ARMs have a fixed interest rate at the beginning of the loan. After the introductory period ends, there will be periodic adjustments to the interest rate over time. The initial fixed-rate period may be for a lower interest rate than you would get with a fixed-rate mortgage. Sometimes, they’re referred to as “teaser” rates.
ARMs are either traditional or hybrid. Traditional ARMs have a fixed interest period of one year. Hybrid ARMs have fixed interest periods of three, five, seven or 10 years. The term on ARMs is usually 30 years.
Adjustable-rate versus fixed-rate
Fixed-rate mortgages allow you to lock in your principal and interest payments over the life of the loan. If you get a 30-year fixed-rate mortgage, your payments will be relatively consistent over that span. There can still be some fluctuation in your monthly mortgage payment because of taxes and homeowners insurance, but for many, the consistency makes it easier to budget and manage.
ARMs come with more uncertainty built in. There’s the rate you lock in for the introductory period, but once it ends, interest rates can increase, which can impact your monthly payment. How much interest rates can rise is capped depending on the type of ARM.
Types of VA ARMs
The type of ARM you can get depends on the length of the initial introductory rate period.
- Traditional ARM: The introductory rate lasts one year. After that, interest rates are adjusted on an annual basis. Adjustments are limited to an increase or decrease of one percentage point per year. Increases are limited to five total points over the life of the loan.
- 3/1 ARM: The introductory interest rate lasts for three years. After that, the interest rate is adjusted annually. The initial adjustment is limited to an increase or decrease of one percentage point with a maximum increase of five points over the life of the loan.
- 5/1 ARM: The introductory rate lasts five years. After that, interest rates adjust annually. The initial increase or decrease is limited to two percentage points with a maximum adjustment of six points over the life of the loan.
- 7/1 ARM: The introductory rate lasts seven years and then adjusts annually. The initial adjustment is limited to two percentage points and then six over the loan term.
- 10/1 ARM: Ten years for the introductory period with annual adjustments after that. Initial adjustment is limited to two percentage points and then six over the loan term.
One way to distinguish the different types of VA ARMs is to focus on the first number. That’s how many years the introductory rate period lasts.
How are VA ARM rates calculated?
Generally, mortgage rates are determined by a complex set of factors that include categories like market conditions, the lender you choose and your personal financial situation. These factors will be considered when the lender offers you your initial “teaser” rate for an ARM.
After the introductory rate expires, your interest rate will adjust based on market conditions, not your personal finances. The two relevant terms here are the index and the margin:
- Index: The interest rate that fluctuates with general market conditions.
- Margin: An amount the lender charges, in addition to the index, to cover their business costs and turn a profit.
The index plus the margin will equal your loan change. Lenders have no control over the index, but margins can vary widely by lender.
Adjustment caps
There are limits to how much your interest rate can increase or decrease after the introductory period expires.
- Traditional (one-year) introductory period: Annual rate adjustments are limited to one percentage point change each year and five total over the loan term.
- Less than five years: Increases and decreases are capped at one percentage point per year and five total over the life of the loan.
- Five years or more: Annual rate adjustments are capped at two percentage points per year and six total over the loan term.
Potential advantages and risks of VA ARMs
Here’s a general list of pros and cons to keep in mind if you’re considering this type of loan.
Pros
- The initial teaser rate for a VA adjustable-rate mortgage is typically lower than you can get with a fixed-rate loan.
- The lower interest rate can translate to lower monthly mortgage payments during the introductory period.
- The adjustment caps provide some protection for how much your interest rate can increase per year and over the life of the loan. This limits how much your monthly payment can increase as well.
- You have the option to refinance later into a fixed-rate mortgage.
Cons
- After the introductory period ends, your interest rate will fluctuate every year, making payments harder to predict.
- Your interest rate could increase after the introductory period, increasing your mortgage payment.
- The adjustment caps also apply to interest rate decreases. That means even if interest rates fall significantly, the amount yours can decrease will be limited.
VA adjustable-rate mortgage requirements
Underwriting requirements for VA ARM loans are generally the same as for VA loans. The only difference is if you apply for a traditional ARM. Because the teaser interest rate expires after a year, you must be able to qualify for the loan with an interest rate one point higher than the teaser rate. That means you would be able to afford a monthly payment with a higher interest rate. For hybrid ARMs, if you qualify for the teaser rate, you can be approved for the loan.
Below are the typical requirements for VA loans.
Stable income
Lenders will review your income history to make sure you can pay back the mortgage. One of the things they look for is a stable income. If you work for an employer, they prefer at least two years of employment. If you’ve been employed less than two years, it’s still possible to qualify, but you may be asked for additional information.
Cash to close
One of the perks of VA loans is it’s possible to qualify without a down payment. However, you will need cash to cover closing costs.
Credit score
The VA doesn’t set a minimum credit score requirement. This gives VA-approved lenders the freedom to set their own. However, lenders are still required to analyze your credit history. If you don’t have a credit history, it’s not considered an adverse factor, but you will likely be asked for more information for the lender to make their assessment.
Debt-to-income ratio
Your lender will also analyze your debt-to-income (DTI) ratio as part of the application process. A DTI ratio of 41% or lower is the standard target ratio. It’s still possible to qualify if your DTI ratio is higher, but your lender will need to review your application for acceptable compensating factors.
In summary
VA ARMs can be an appealing option because of the introductory teaser interest rate. The requirements for most ARMs are also the same as those for fixed-rate VA loans. However, keep in mind that rates can potentially increase after the introductory period ends. That period will be clear up front, so it can be accounted for in financial planning.
