When looking at various ARM loans, you might have seen ratios like 3/1, 5/1, 7/1, and 10/1. Confused? The numbers are actually quite simple. The type of loan we’re talking about here is a hybrid VA 5-1 arm loan. That means the first portion of the loan is set at a fixed rate while the remaining portion is adjustable. The first number in the ratios above indicates for how many years the first portion will last while the second indicates when rates will change during the adjustable portion. For various reasons, the hybrid ARM loans offer a fixed-rate period of three, five, seven, or 10 years. In this article, I’m going to talk about the VA 5-1 ARM option in particular. This really isn’t going to be a lot different from the other options, but there are a few key factors that determine whether this is the best option for you.
How the VA 5-1 ARM is Different
The VA 5/1 ARM will have a set interest rate for the first five years of the loan and then will adjust every year after that for the remaining twenty-five years of the loan. Because of this, the initial rates will likely be lower than standard ARMs and even may be a little different than the other options for hybrid ARMs.
The first two questions you should ask yourself when considering which home loan to get is what will my income be like in the coming years? And what are my future house plans?
The answers to these questions will tell a lot. For example, if you plan on moving in the next 5 years, the 5/1 ARM might complement your plans perfectly, since rates will be fixed throughout your stay in that house. If you don’t plan on moving for at least another decade, and you know interest rates will likely rise in the near future, you might be better off with a fixed-rate mortgage.
Beyond this, you should consider whether you will be able to pay more than your payments each month and for how long. If you could keep this up for five years, then paying the second period’s rates on the 5/1 will be easy since the loan reamortizes based on what you’ve already paid.
To analyze whether the 5/1 will work for your individual situation, you need to get a few pieces of information directly from your lender.
With all ARMs, you need to know the:
- Index that is used
- Dates when rates will change
- Max rate over life of loan
Thankfully, with a VA hybrid loan, there are mandated caps put in place that make these loans a lot more stable. After the fixed-rate period, rates can only change once a year on the anniversary of the loan and can rise no higher than an added one percent each year. Over the entire life of the loan, the rates cannot increase more than five percent above the original rate. Remember that the rates won’t necessarily go higher—they might even drop depending on the index rates. This loan will let you take advantage of sudden interest-rate drops, which gives the VA 5-1 ARM hybrid loan, a pretty big advantage over a standard fixed-rate mortgage.
A lot of people who get a 5/1 hybrid ARM loan go into it assuming they will move within five years. They wouldn’t have to worry about the adjustable-rate period if this was the case. While this argument makes sense, the future is uncertain. Even if you are relatively sure, you still shouldn’t pursue the 5/1, or other ARM loans, unless you can handle a possible rise in rates.
Advantages: The VA 5/1 hybrid ARM benefits from an interest-rate drop in the market after the first five years. Principal is paid faster. The initial rates are often much lower. The VA sets predictable limits on how much and when your rates can change.
Disadvantages: Rates can increase, giving you much higher payments. Whether rates will go up or down is unpredictable.