Understanding the VA Hybrid Loan

UnderstandingVAHybrid
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The VA Hybrid Loan is a great option for many military homeowners to assist veterans in saving hundreds of dollars per month. However, there are many misconceptions and negative perceptions surrounding the VA Hybrid Loan.

Many military homeowners assume any loan outside of a 30-year fixed loan is toxic and a bad option. This is not true and many homeowners are steering away from loans that may be better options for their specific circumstances.

The VA Hybrid e-book was created to give homeowners all the details about the VA Hybrid loan and try and explain the benefits to veteran homeowners. We hope you enjoy the e-book and have a greater understanding of the VA Hybrid Loan.

Click Here to View the e-book

 

The VA Mortgage for the Empty-Nester

 15-Yr Fixed or Hybrid ARM

Hybrid or Fixed

Not all mortgage options are appropriate for every situation. A veteran whose children have all grown up and moved out on their own has very different priorities and needs than a young veteran just after discharge. There is a lot of confusing information out there on what you should do with your mortgage and much of it is misleading. Our goal here in this article is to help you figure out what’s best for you and your future. We’ll cover the three options that are usually the best choices for you: sticking with what you have, getting a 15-year fixed, or getting a VA hybrid ARM.

 

You may be better off sticking with what you have

 

Chances are you’ve already built a lot of equity in your home over the years, and you may be 15 years into a 30-year fixed. If that’s the case, often the best way to save money is to ride the wave all the way in. Why? Because a much larger chunk of your monthly payment is paying down principal than it would if you were to refinance to a 15-year fixed or possibly even a Hybrid ARM, plus you have the assurance that your monthly payment is never going to increase beyond increases in taxes and insurance. This can be comforting if you’re on a fixed income. However, you should take a look at what interest rates you can qualify for on a 15-year fixed and a hybrid ARM, and make a loan officer do the hard work of comparing the total interest paid, starting monthly payment, and payoff date of all three of your options. If you can get a significantly lower interest rate on a Hybrid ARM (very likely right now) than you currently have, it may be worth the closing costs to get one.

 

The 15-Year Fixed

 

You may be asking, why not a 30-year fixed? A 30-year fixed is probably the worst thing you could do at this stage, because you’re going to get a higher interest rate, higher closing costs, and make it extremely unlikely that you’ll ever fully pay off your home. On a 15-year fixed, especially if you have a fair amount of equity in the home, you’ll definitely get a lower interest rate than you could refinancing to a 30-year fixed, and your monthly payment may very possibly get lower than what you’re currently paying even though you’re paying off more principal with each payment. Also, for those who just can’t stomach the risk of a hybrid ARM (though it’s much less than you might expect), the 15-year fixed provides a stable, predictable, and better option than the 30-year fixed. If you can afford it, the more you can pay each month above the minimum payment the better off you will be. You’ll be saving yourself a great deal in interest over the life of the loan.

 

The VA Hybrid ARM

 

ARMs have a bad reputation, but the VA hybrid ARM is likely to be one of the best options you can get no matter what stage of life you’re in. First of all, the starting interest rate you can get could be as little as half what you can get on a 30 or 15-year fixed, which not only drops your minimum payment significantly, but allows you to throw a lot more money on principal each month if you continue to pay the same each month as you pay now. We won’t go into too much detail on the hybrid ARM here, but know that hybrid ARMs can only adjust once per year, are only allowed to adjust by up to 1% each year, and cannot increase by more than 5% over the life of the loan. Since you can start your ARM at 2.25% right now (as of the writing of this article), that means your interest rate could never get higher than 7.25% and it would take at least 5 years after the initial fixed period (so 8-10 years into the loan) to get that high even in a worst-case scenario. Depending on how much equity you already have, you may very well be able to completely pay off your home before then anyway. If the Hybrid ARM is still more risk than you’re willing to take on, then the 15-year fixed is a good option as well.

 

Mortgage for the Frequent Mover

The Mortgage for the Frequent Mover – the VA Hybrid ARM

 

Home-ownership is a fundamental step in building your wealth. Not only that, home-ownership means freedom to customize and adapt your dwelling to however you want it to be. Owning a home offers a far higher level of freedom than renting. But as we all know, with great power freedom comes great responsibility – owning a home also means paying property taxes, maintaining homeowners insurance, and paying interest on your mortgage. It also means replacing expensive appliances and utilities when they break down and being the one who has to deal with it when a group of teenagers drives off the road, crashes into your fence, then hightails it before you can get the license plate. Not only that, but buying a house is really expensive; your lender takes their cut, the title company takes theirs, and even the VA takes a cut if you’re doing a VA loan. So why on earth would anyone buy a house if they were only going to live there for a few years?

 

YFrequent Moverou may be asking yourself this question if you’re still on active-duty, or are just the kind of person that likes a change of scenery every few years. You’ve probably decided that it’s not worth penny-pinching for three years just to pay closing costs for the next time you move. Renting is just a better option – not only for the lack of headaches, but also because it’s the best financial decision over the long term…or is it? If you’ve decided that renting is the best option for you, it’s probably because you don’t know as much about the VA loan Hybrid ARM as you should.

 

The VA loan hybrid ARM solves pretty much every problem that there is with buying a house for only a few years. Closing costs are much more affordable than for a fixed-rate mortgage and interest rates are much lower. You are also able to roll the VA funding fee into the loan amount rather than paying it upfront. So how does a hybrid ARM work? It’s pretty simple; it starts out as a fixed interest rate for either the first 3 years or the first 5 years. After that initial period, the interest rate adjusts once per year based on the CMT (an extremely docile index), and can never adjust more than 1% per year, and can never get more than 5% higher than what it started from in the fixed period.

 

So what did I just say? Here it is again:

  • lower closing costs
  • lower interest rate
  • roll VA funding fee into loan
  • extremely low, fixed rate for first 3-5 years
  • rate adjustments are based on CMT
  • can never adjust more than 1% per year
  • can never go higher than 5% above starting rate.

 

So whether your PCS orders come in 1 year or 5 years, you’re pretty much guaranteed to be better off with a hybrid ARM than either buying with a fixed-rate or just renting. As of the writing of this article, LowVARates is offering ARM rates starting at around 2% for the initial fixed period. In case you don’t know, that’s about half what conventional borrowers are getting on a 30-year fixed. So let’s assume you get a 3/1 hybrid ARM (initial fixed period is 3 years) and opt for the 2.25% interest rate (comes with a lower margin after the fixed period than lower initial rate options), and your PCS orders (or your decision to move) don’t come until 5 years later. Even in a worst case scenario, your interest rate can only get as high as 4.25% before you move, which means you’ll have paid off a bunch of principal on the home and have equity (barring another recession) on the home by the time you move. Would you rather throw money away on rent or convert money into equity in your home then back into cash when you move? This is why we consider VA Hybrid ARMs let you movethe VA hybrid ARM ideal for borrowers who are planning on moving in the next few years.

 

FAQ; What if a hybrid ARM rate goes up

What if Rates Keep Going Up?

 

FAQ_ArmsLet’s get to the root of this question: How big is the risk you’re taking by getting a hybrid ARM instead of a fixed-rate? Well, let’s talk about it. First, we’ll talk about the safeguards that the VA has put in place on a hybrid ARM to protect borrowers from getting sky-high interest rates, then we’ll take a look at what the CMT index has done over the last little while to get a feel for how likely it is that it’s going to jump up a large amount over an extended period of time. Finally, we’ll wrap up by talking about whether it’s worth the risk and what is the smartest thing to do for your mortgage.

 

The VA has put some very important safeguards in place to make sure that VA borrowers are not put in a bad spot by getting a hybrid ARM. The first safeguard is actually the initial fixed period itself. At the beginning of the loan, more of your monthly payment is going towards interest than at any other time during the loan, so getting an insanely low interest rate for the first 3-5 years can save you a lot of money in a very short amount of time. After the initial period, the VA hybrid ARM can only be adjusted once each year, and cannot adjust more than 1% in any given year. This means that even if rates skyrocket after your fixed period, you’ll be the tortoise chasing the hare. Lastly, the VA does not allow an interest rate to increase more than 5% over the life of the loan, even if market rates go much higher than that. Considering that you have up to 5 years at a fixed rate, then it would take a minimum of 5 years for the interest rate to rise the full 5% (by the way, this has never happened in the history of the CMT index – ever. Literally, your chances of dying by getting hit by a meteor are higher than this happening.) So it would take 10 years for your loan to max out by then, and since the average time between refinances or moves for american families is between 3 and 5 years, you will probably have moved or refinanced by that point anyway.

 

So how has the CMT index performed over the last while? Well, below is a graph that shows you what the CMT index has done since February of 1992. As you can see, while there are years where the CMT does go up, it has never gone up for more than 3 years in a row. The specific color you should be looking at is the blue line, which indicates the 1-year CMT that will be used to calculate your hybrid ARM index.

 

So the CMT index does not have a habit of increasing for very many years in a row. While the index can jump several percentage points in just one or two years, it doesn’t generally maintain growth for longer than 2-3 years.

 

What does all this mean? Well, since the hybrid ARM is limited to increase more than 1% each year, it doesn’t matter if the index jumps 1% or 10% in a year; you’ll only go up 1%. As long as the index comes back down (which it has for the last 22 years), your rate will go down as well. While it may go up slowly over time, we’re talking between 15-25 years, and by then you’ve saved so much money over your fixed-rate buddies that you’ll almost certainly still come out ahead. Asking “what if” about the worst-case scenario with your rate is an exercise in futility in this case. While planning for the worst is often a good practice, it can be taken to extremes, and this is one of the cases where trying to “plan for the worst” is just going to rob you of opportunities and benefits you could otherwise enjoy. Much like refusing to leave your house because you might get hit by a car, deciding against a hybrid ARM because you’re afraid of your rate rising as far as it can as fast as it can is more paranoia than caution.

 

The Advantages of a VA Hybrid ARM

What Advantages Does a VA Hybrid ARM Offer?

This article is mostly taken from our VA Hybrid ARM Guide from our website. For more information on Va Hybrid ARMs, please check out the full guide.

VA Hybrid ARM Advantages

The first and most obvious advantage is getting a lower starting interest rate than on a fixed-rate mortgage. A Hybrid ARM finds a fantastic middle-ground between fixed-rate and adjustable-rate mortgages. Fixed-rate mortgages can be frustrating if interest rates fall after you’ve gotten your loan, and adjustable-rate mortgages can be risky if interest rates rise significantly over the life of the loan. In a Hybrid ARM, you and the lender both get the potential benefit of having your interest rate adjust with time, but you also have two assurances to mitigate your risk: your rate is only adjustable after the first 3 years or the first 5 years, and it can adjust by no more than 1% per year. This offers an amazing amount of benefits to you as the borrower. Consider the following example:

 

You purchase a home using a 5-year Hybrid ARM, which means that your interest rate will be fixed for the first 5 years of the mortgage, after which it will adjust annually no more than 1% in either direction and a lifetime cap of 5%. No matter whether interest rates got lower or higher during the first 5 years, you’re in a great position. If interest rates got lower, your interest rate will automatically begin adjusting accordingly, without you having to go through the time, trouble, and a fair amount of money to get a refinance. If interest rates got higher, your loan may still take years to catch up to the current rate, and if the rise was dramatic enough (more than an additional 5%), your loan may always stay lower than what you could get if you refinanced. In other words, no matter what your plans for the home you are buying are, getting a VA Hybrid ARM instead of a fixed-rate or a regular ARM can save you money.

 

Being quite honest, despite some myths, VA Hybrid ARMs are advantageous in almost every situation, but there are some situations that get even more benefit out of the Hybrid ARM than others. For example, if you are not intending to live in your home longer than 5 years, you get an enormous amount of value in a Hybrid ARM because you get a lower interest rate than you could in a fixed-rate mortgage, and you never have to worry about it adjusting because you’ll be selling before it does. Hybrid ARMs also offer a more significant benefit if you expect to be able to make more than the minimum payment for the first few years of the loan term, but not necessarily after (e.g. your children will be college-age in about 5 years and at that time you will likely need to divert more money to helping them through college). Since the rate stays fixed and relatively low for the first 5 years, you can knock the principal down each month ahead of the amortization schedule, so even if the rate gets higher after the initial term, your monthly payment doesn’t get as much higher, if it increases at all.

 

Lastly, if you are expecting to live in your home until it is completely paid off, a VA Hybrid ARM can save you tens of thousands of dollars over the life of the loan. How? Consider the following example:
You buy a house intending to grow old in it. By choosing a Hybrid ARM, you get the benefits of a refinance (a lower interest rate if rates have gone down) without the cost (thousands of dollars in closing costs). Unless you’re looking to get cash-out to consolidate debt, there is no need to refinance a Hybrid ARM, because it adjusts annually towards the current interest rate. In addition to the thousands of dollars saved due to not needing to refinance, you are also enjoying a lower interest rate than you could have gotten with a fixed-rate mortgage (especially during the initial 3 or 5-year term, where you pay more interest per month than any other time during the loan), which can save you thousands of dollars more over the life of the loan. How much money can you save? Let’s say you buy a $200,000 home at an interest rate of 4.0%. How much money do you save compared to a $200,000 home at 4.5%? Roughly $20,000 of interest  over 30 years. Imagine how much money a difference of an entire percent or more could save you.

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