You have a lot of decisions to make when you take out a VA loan. Of course, you must decide on a loan amount, but you must also choose the term, interest rate you want to lock, and the type of loan. Typically, you only had VA fixed rate and ARM options, but today there’s another option called the VA hybrid loan.
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Keep reading to learn how this loan works.
The VA Hybrid Loan Explained
The VA Hybrid Loan is a combination of the fixed rate and ARM loan together. It’s like getting the best of both worlds. The loan is fixed for a certain period and then adjusts annually after that point. This differs from the standard ARM which adjusted annually, making it a riskier option for buyers.
You’ll see the VA Hybrid Loan signified with the number of years it’s fixed first, followed by the frequency of the adjustments. For example, a 3/1 loan is fixed for three years and then adjusts one time per year after that point.
How the Rate Adjusts
Now, it’s important to understand how the rate adjusts so that you can determine if it’s the right program for you.
Each hybrid loan has an index, margin, and caps that play a role in how much the rate adjusts.
- Index – The index is the chosen starting point for the rate. Lenders often choose between the LIBOR, 1-year Treasury Index, or Prime Rate. The index obviously changes often, so you can’t predict what your rate will start at because of its changing status.
- Margin – The margin is the amount the lender adds to the index. This number never changes. For example, if the lender gives you a 2% margin, you’ll always add 2% to the current index on your anniversary date to get your new rate.
The Role of the Caps
The rate caps help your rate stay somewhat manageable. In other words, the caps stop the rate from increasing or even decreasing too much. The lender will give you three types of caps.
- Initial adjustment cap – This is the most your interest rate can change on your first anniversary date. This cap helps keep your first payment from skyrocketing and leaving you unable to afford your new payment.
- Annual adjustment cap – This is the most your rate can change during any anniversary rate change. It helps keep things manageable for you. Typically, the annual adjustment cap is 1%, but each lender has their own requirements.
- Lifetime adjustment cap – This is the most the rate can change over the life of the loan from its starting rate. Typically, this cap is 5%, but it can depend on the lender. This cap helps you understand the worst-case scenario should your rate change drastically.
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Who Should Use the Hybrid Loan?
You may wonder who would ever want a rate that adjusts when they could choose a fixed rate loan. While it seems crazy, there are some ways that certain borrowers benefit.
- Borrowers that want a lower initial payment – You may be able to get a lower interest rate than a fixed rate when you choose the hybrid loan. Of course, the low rate doesn’t last forever, but it can help you save money for the first few years, helping you to come up with a long-term plan.
- Borrowers that will move soon – If you know the home you buy now is only temporary, you can take advantage of the lower interest rate. If you move before the rate adjusts, you’ll never have to worry about adjusting rates.
- Borrowers that have income that will increase – If you just started your career, but know that you’ll make more money in the near future (such as doctors or lawyers starting as interns), you can take advantage of the lower rate now. This can make your payments affordable while your income is low and then adjust as your income increases.
Refinancing Out of the Hybrid Loan
You can always refinance out of the Hybrid Loan too. If you don’t want to take the chance of dealing with an adjusted rate, refinance before the anniversary date of your rate change. This way you get the advantage of the lower rate and then get out before anything changes.
One perk that veterans have is the VA IRRRL program. The Interest Rate Reduction Refinance Loan allows you to refinance with very little verification. You provide proof that you made your last 12 mortgage payments on time and that you benefit from the refinance and chances are you will get approved. This allows you to refinance from the ARM to a fixed rate loan, taking the worry of an adjustable rate out of the picture.
The VA Hybrid Loan has its benefits and can help many veterans that need that lower payment when they first buy a home. As always, make sure you comparison shop to find the rate that works best for you. Many lenders offer this great program that makes homeownership possible.
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