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VA Hybrid Loan

By: Grant Moon 09/24/12 03:16 pm

VA Hybrid Loan

It seems the term “hybrid” has been making a comeback lately.  Automobile makers all tout their latest “hybrid” technology.  Yet in the VA mortgage world, the term also has its own meaning.  And just as a hybrid automobile combines two types of energy sources, so does the VA hybrid loan. How’s that?

A VA hybrid loan is a mix between two mortgage types: a fixed and an adjustable rate loan.  At first glance that seems contradictory and in fact it’s not really a fixed rate at all but a different version of an adjustable rate mortgage, or ARM.

The hybrid loan is so called because the loan if fixed for an initial period, five years, then turns into an ARM for the remaining term of the loan with typical caps that all ARMs have.  For example, a VA 5/1 hybrid loan may be fixed for the first five years at 3.00 percent. At the end of the first five years, the loan morphs into an ARM.

When the loan turns into an ARM, the index (which is the 1-year Constant Maturity Index, or CMT) is added to the margin. A common margin for the VA hybrid is 2.00 percent.  If this loan were to adjust today and the CMT is .20 percent and the margin 2.00 percent, your new rate for the next 12 months would be 2.20 percent. The next year the process would begin all over again, year after year, until the loan is retired.  But what if interest rates were to skyrocket seven years from now and the CMT was 9.00 percent?  Caps come into play.

If the index were indeed 9.00 percent and the margin 2.00, the new rate would be 11.00 percent.  But there are consumer protections called “caps” which limit how much the rate can move both on a lifetime and annual basis.  Regardless of what the rates might be in the future, the rate can go no higher than five percent above the initial rate and no more than one percent over the previous year’s rate. That’s where the 5/1 comes into play: fixed for five years, five percent lifetime cap and a one percent annual cap.

These hybrids are attractive when mortgage rates are relatively high compared to ARMs.  When deciding between a fixed rate mortgage and an ARM, remember there’s a third choice: the hybrid.

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