VA vs. Conventional ARM Loans

VA Vs. Conventional: The ARM Loan

 

The VA loan program has a very different offering in terms of ARM (adjustable-rate mortgage) loans than the conventional loan program. Why is this relevant? Because the VA’s ARM option (technically called a ‘hybrid ARM’) is significantly better than the conventional ARM option. To adequately explain how a VA ARM is better than a conventional ARM, we’ll first go over some ARM basics, then talk about the conventional ARM, then talk about the VA ARM.

 

ARM Basics

An adjustable rate mortgage is exactly what it sounds like; a mortgage in which the interest rate periodically adjusts. An ARM is the opposite of a fixed-rate mortgage. ARMs have typically been given a pretty bad rap, and in fact are often what people point fingers at to blame for the housing market bubble bursting. While the role ARMs played in the housing bubble is debatable, the fact that some ARMs are better or worse than others is indisputable. ARM loans typically are limited to annual adjustments, and usually have a lifetime cap of how high they can rise above their starting rate, as well as adjustment ceilings for how much it can fluctuate. ARM interest rates are calculated by combining the margin a lender offers at the beginning of the loan, which can’t change after closing, with the index being used for that ARM loan. With those basics out of the way, let’s talk about the different offerings.

 

The Conventional ARM

Conventional ARMs are generally not that great. Both VA and FHA ARMs have the leg-up on on Conventional ARMs. The conventional ARM usually adjust once per year, but the frequency of rate adjustments is something to keep an eye on if you’re applying for one. When a conventional ARM adjusts, it can go as much as 2% higher than it was previously, which can make for some drastic increases depending on the market activity. However, the conventional ARM does have a lifetime cap of 5% higher than the starting rate, so no matter what the market does, your loan can never be higher than 5%. Conventional ARMs typically start with a fixed period of 3-10 years, after which the rate starts adjusting. It’s important to know that on a conventional ARM, the very first year it adjusts, it can adjust as far as it needs to to catch up with where the market is at that time, up to the 5% lifetime cap. In other words, even the minimal 2% annual cap protection is not present in the first adjustment. The conventional ARM uses the LIBOR index, which can be volatile and result in less predictable adjustments.

 

The VA Hybrid ARM

The VA Hybrid ARM is a different story. VA ARMs also adjust once per year, but they have an annual adjustment cap of no more than 1% higher, and that protection is in place for the first adjustment after the fixed period. Fixed periods on VA ARMs are typically shorter, between 3 and 7 years, but starting interest rates are even lower than on conventional ARMs. VA ARMs share the 5% lifetime cap with conventional ARMs, but when combined with a 1% annual adjustment limit, this is a far more reasonable limitation. VA ARMs use the 1-year CMT for their index, which is an average of the CMT activity for the last 12 months. This averaging makes the CMT much more smooth and less volatile than the LIBOR, which results in easier-to-predict adjustments that generally aren’t as likely to jump up or drop down very drastically.

 

It’s All In The Numbers

If you want to know for sure how much better a VA ARM would be for you than a conventional ARM, apply for an ARM with two different lenders, one conventional and one VA, and that will be your proof. ARMs are great in that they start with (usually) a much lower interest rate than fixed-rate mortgages, with the tradeoff that they can adjust over time. If you have the protections built-in that the VA ARM comes with, the risk of suddenly having a payment you can’t afford is much, much lower, and the chances that you’ll end up paying more in the long run for your ARM is much lower as well.

 

VA Loans vs. Conventional Loans – Which is better?

What should you choose?  VA or Conventional?

At some point Veterans will come to a dilemma when deciding what type of loan to use when buying a home.  This is a very valid question or concern as both have their place in the home buying process.  Having worked with Veterans for the past 7 years I can shed some light on this subject.  First let me start by saying that owning your own home is still one of the best financial decisions an individual can make if its done right.  What I mean by that is simply don’t bite off more than you can chew.  Once you sign on that dotted line you are now responsible for making payments for the next 15 to 30 yrs.  BE SMART ABOUT IT.  OK, lets analyze the VA loan and Conventional loan.

VA loans allow NO MONEY DOWN 100% financing

VA loans  allow for a Veteran to borrow 100% of the purchase price.  This now is one of the only loan programs that allow for 100% financing.  Unlike Conventional loans, you don’t have to pay any mortgage insurance premium (MIP) on Veteran Home Loans.  MIP is a separate insurance that covers the lender in case of loan default.  The amount of MIP is paid on a monthly basis and is completely risk based and can be very expensive.  The reason why a Veteran does not have to pay this is simple.  The Department of Veteran Affairs is guaranteeing a portion of the loan to the lender.  This is what is commonly known as your VA entitlement.  For the Dept of Veteran Affairs to guarantee a VA loan to the lender there is a fee assessed by the VA.  This is called a VA Funding Fee (VAFF).  The amount of this fee is usually 2.15% of the loan amount and it CAN BE financed into the loan.  This fee can be decreased if the Veteran puts money down and will also be waived is the Veteran is receiving 10% or more VA disability.  In this day and age, who has $20,000 just laying around to put down on home.  This is just my opinion, but if you have that much money saved its better left in an interest bearing account.  Besides, all the interest on home loans is tax deductible so on that $20k you will will gain interest and be able to deduct more interest on your home.

Do I need to have great credit?

Credit Qualifications on VA loans are much different than conventional loans.  With VA loans its based on timely payments within the last 12 months whereas Conventional loans are score driven.  A Veteran who has a credit score of 620 can get them same rate as someone with an 800 credit score.

How much money do I have to make?

There is an additional step with VA loans.  VA is not so concerned about Debt to Income (DTI) but rather Residual Income (RI).  The Department of Veteran Affairs has established a calculation based on family size, loan size and location and takes into account net income (after taxes).  Conventional calculates DTI on gross income (before taxes).

These are the main differences between VA loans and Conventional Loans.  If a Veteran has served his country and helped the cause of Freedom and is given the ability to use a VA loan, there is no reason why he/she should not use it.  I’ve done both VA and Conventional loans.  VA LOANS provide lower monthly payments.  This industry is changing so much. It isn’t what it used to be but the VA loan has remained constant.  Good luck and happy house hunting.

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*Annual savings calculator based on 2015 monthly average savings extrapolated year-to-date.