VA loans are probably one of the most misunderstood loan programs available today. Not only do many sellers mistakenly think that VA loans are impossible to get to the closing table, many veterans think the only loan they can get is a fixed rate mortgage.
Just like any other mortgage program, the VA offers fixed rate, adjustable rate, and hybrid adjustable rate mortgages. Understanding how each of them works can help you determine which mortgage is right for you.
Fixed Rate VA Loans
Fixed rate VA loans are probably the most common type of loans veterans get. It could be because it’s the most well-known. Fixed rate loans definitely have their advantages though. On top of the no down payment and flexible underwriting guidelines, veterans taking a fixed rate loan enjoy:
- A fixed rate for the life of the loan
- A stable monthly payment with the exception of the changing escrow payment, if applicable
- You can budget easier always knowing your mortgage payment
- You can easily compare two fixed-rate mortgages to one another without complication
There aren’t many parts to the fixed rate loan. You know your interest rate and your monthly payment. That’s all there is to the equation. You are free to make extra payments towards your loan if you are able too. This knocks down the principal, which in turn, knocks down the total interest you pay over the life of the loan.
Adjustable Rate VA Loans
As the name suggests, an adjustable rate loan doesn’t have a stagnant interest rate. The rate changes with the market. You usually start the loan off with what they call a ‘teaser’ rate. This is the rate to entice you to take the adjustable rate loan.
After the first year, the rate changes according to the chosen index. The lender chooses, the index, such as the LIBOR, to base your interest rate. The lender also determines a margin. This is a fixed number that the lender adds to the market value of the chosen index on the adjustment date. For example, if the margin is 2%, the lender will add 2% to the LIBOR’s rate on your adjustment date.
Adjustable rate loans have caps or maximum amounts that they can adjust. The lender will usually set a few caps including:
- First year cap – This is the maximum amount the interest rate can change on the first change date.
- Lifetime cap – This is the most the rate can change over the life of the loan. If the rate hits the cap, it cannot adjust any higher for the life of the loan.
- Periodic cap – This is the maximum amount the rate can change on any given date.
Adjustable rate loans generally adjust annually, but some lenders offer different frequencies. It’s important to understand exactly how the adjustable rate loan works before you take it. While it sounds risk, adjustable rate loans do have a few advantages:
- You get a lower payment for the first year
- You may be able to qualify for a higher loan amount with the lower payment
- The rate does have the ability to decrease if the market falls
- You can refinance into a fixed rate loan at any time if the payments get too high
Hybrid Adjustable Rate Loan
The hybrid adjustable rate loan is a combination of the fixed rate and adjustable rate loan. With this loan, the rate is fixed for a few years, typically 3 – 5 years. After that point, the loan becomes an adjustable rate loan. This means the rate depends on its corresponding index plus the predetermined margin.
Just like the adjustable rate loan, the hybrid loan has maximums or caps that the interest rate can change. This helps to keep the payment under control. The rate will adjust on an annual basis, but not until the fixed rate period ends.
Hybrid adjustable loans have some benefits as well, including:
- You get the lower payment for a few years
- You can sell the home and pay the loan off before the rate even adjusts
- You may qualify for a higher loan amount with the lower payment
- You can take advantage of decreasing rates if the market does poorly
VA loans have just as many options as any other loan program. Veterans can choose among the various terms to decide which one is right for them. We recommend that you get a quote for all three mortgage terms to decide which one is right for you.
Make sure that you look at the interest rate, APR, and terms of the loan. Ask the lender the worst-case scenario regarding the interest rate. This way you can see if it’s a payment you would be able to afford if it became your reality.