Interest rates are one of the first things you pay attention to when thinking about getting a loan. This is especially true when buying a house. Mortgages are big loans, paid off over a long period of time. A difference as small as a quarter percent can mean hundreds or even thousands of dollars paid over the life of the loan. The same applies to your VA mortgage loan. But how are VA loan rates determined? How often do VA loan rates change? How do they compare to conventional or FHA mortgages? This article will answer these questions for you and help you understand everything that surrounds how lenders arrive at the amount of interest to charge you for your loan.
VA Home Loan Interest Rates Overview
Interest is the cost of borrowing money. If you are a borrower, you pay interest on a loan. If you are a lender, you earn interest. For example, when you get a car loan, you pay interest on that loan because a bank advances the money to you up front. On the flip side, when you keep your money in a bank, you earn interest on that money because you’re loaning money for them to invest. Mortgage interest rates are decided by many factors, from your personal financial history down to the type of mortgage you decide to apply for. This is true whether you are seeking a conventional loan or using your VA benefit. Let’s start by discussing your financial history and things lenders look for.
When applying for a VA home loan, keep in mind that the Veteran’s Administration does not have any influence over an interest rate. The VA is not a bank. All it does is guarantee, on your behalf, 25% re-payment of the loan if you fail to make your mortgage payments in a timely manner. This is a very important benefit, because it lowers the overall risk of loaning you the money. Credit risk is extremely important to lenders when qualifying someone for a loan. VA loan requirements may differ from lender to lender based on overlays. Your interest rate often directly correlates to how your credit risk looks from the lenders perspective. They determine your credit risk using your credit score, credit history, income and expenses.
The first thing lenders tend to look at is your credit score. The credit score used most often is the score calculated by the Fair Isaac Corporation, also known as your FICO score. FICO looks at your credit history and creates a score based on your payment history, total debt load, length and age of your credit history and your overall credit mix. It then assigns you a 3-digit number. The higher the number the better your credit score, and ideally, the lower your credit risk. The scores break down as follows:
· Exceptional: 800+
· Very good: 740 to 799
· Good: 670 to 739
· Fair: 580 to 669
· Poor: 579 and below
The VA does not require a minimum credit score to qualify for a loan. Lenders tend to be more lenient about your credit score because of the VA guarantee. In general, most lenders will need a
minimum credit score of 620, although some lenders may go as low as 580. In general, the better your credit score, the lower your interest rate will be. There are many ways to check your credit score for free, so it’s a good idea to find out where you stand before you start the loan process. If you find your score is below 600, it’s best to take some time to improve your credit before applying for a loan.
Your FICO score is great for a snapshot view of your credit, but lenders will take a closer look at your credit history to see how you’ve handled your financial wellness. Things such as delinquent accounts (payments made more than 30 days late), unpaid collections, recent applications for credit, bankruptcies and foreclosures will probably raise questions about the reasons behind such blemishes. You probably won’t be denied the loan if you only have one or two issues on your credit report, but it will have a negative impact on your interest rate. You can request copies of your credit history directly from the three credit reporting agencies (Equifax, TransUnion and Experian). It’s a good idea to check all three as they are independent entities and the information may differ slightly between them.
Income and Expenses
Lenders want to see that you and/or your spouse maintains a stable income that allows for proper care of the home and additional expenses. Lenders call this your debt-to-income ratio, or DTI. What expenses do lenders look at when determining your DTI? Your mortgage will be the biggest expense, followed by installment loans such as car and student loans. Credit card payments are also included, as well as any alimony payments or child support. The higher your debt-to-income ratio, the more likely it is you may have trouble making your payments. This makes you a higher credit risk and your interest rate will likely increase.
All of the items mentioned above are a representation of your financial history. While you can certainly improve upon them if necessary, you can’t immediately change them. What you do have direct control over is the type of loan you apply for. There are many different types of loans available in the marketplace. All have advantages and disadvantages, and interest rates vary from loan to loan and lender to lender. If you are eligible for a VA home loan, you qualify for great loan benefits regardless of the type of loan you choose.
VA loan benefit overview
It can’t hurt to quickly revisit the benefits of using your VA benefit to finance your new home. Because your loan is backed by the office of Veteran’s Affairs, you can qualify for your loan with no money down, effectively financing 100% of the price of your home. You also don’t have to worry about paying Private Mortgage Insurance (PMI), which alone lowers your monthly mortgage payment between $100 and $300 compared to conventional or FHA financing. Another benefit to using your VA loan benefit is interest rates are often lower than both conventional and FHA loans. The VA has very comprehensive lending guidelines that go above and beyond those used in regular financing. Because of this, the amount of people who fail to repay their mortgages is low. Lenders know this, and it’s one reason why VA loans often have the benefit of lower interest rates.
Each type of loan listed below has different rules and corresponding interest rates…and have advantages and disadvantages. Remember that it’s all about finding the best loan for your particular situation.
VA Fixed Rate Loans
Fixed rate loans are probably the most popular option you’ll see in the marketplace. Fixed rate loans are just that – the interest rate stays the same over the life of the loan. You can get fixed rate loans for many different terms, including 30-year, 15-year, and sometimes even 25-year mortgages. The benefit of this type of loan is your monthly mortgage payment stays stable throughout the life of the loan. This makes budgeting much easier for you because you always know what to expect. Interest rates vary from lender to lender, so it’s important to shop around. What are VA loan rates today? The average interest rate in September 2019 for a VA 30-year loan was 3.69% as opposed to 3.93% for a conventional loan. In general, you can expect a VA loan rate to be around 0.25% to 0.50% lower than conventional financing.
VA Adjustable Rate Mortgage (ARM)
Adjustable rate mortgages aren’t for everyone, but they can make sense in certain situations. ARM’s often begin with a lower interest rate than a fixed rate mortgage, with the understanding that the rate will be reviewed on a yearly basis and adjusted based on various economic influences. This results in your payments being lower at the beginning of the mortgage, allowing time for your income to grow. It can also be a great option for people who plan to be in the home for five years or less, especially for military service members, as they tend to move around more often that civilians. On the other hand, there is obviously more risk involved with an adjustable rate mortgage. If your payment winds up increasing more than you thought, it could leave you in a precarious situation.
One loan that is becoming increasing popular is an ARM hybrid loan. This type of loan begins with a fixed-rate period and then converts to the traditional adjustable mortgage rate model. It combines the ability to garner a lower interest rate up front with the stability of knowing what your payment will be for a few years. Hybrid loans are available with initial fixed periods of 3, 5, 7 and 10 year terms. The technical name for these loans is the 3/1, 5/1, 7/1 and 10/1 loans.
What happens when the fixed term is up? Let’s assume that you have a VA 5/1 ARM loan with an introductory rate of 2.75%. On the fifth year anniversary of your loan, your lender will check any one of various indexes and based on terms spelled out in the closing documents will adjust the mortgage rate to market conditions. Banks can base this on either the Prime Rate, one year Treasury or the LIBOR (London Interbank Offered Rate) indices plus an added margin agreed upon when you closed your loan. For example, if the LIBOR stands at 0.75% on the anniversary of your loan, and your agreement states that your margin is 2.25%, your lender adds the two together and your new interest rate increases from 2.75% to 3.0%.
The good news is that with a VA hybrid ARM, increases are capped in case of large jumps in the indices. This holds true not only for the yearly adjustments, but also over the life of the loan.
The government protects you by stating that your year-over-year interest rate cannot increase by more than 1% from the previous year, and not more than 5% total over the lifetime of the loan. Therefore, if your 5/1 ARM rate starts at 2.75%, the highest it can go on the anniversary date would be 3.75%. If you keep the loan for the entire 30-year term, the interest rate could not climb to more than 7.5%.
Interest Rate vs. Annual Percentage Rate
When you start to research interest rates, you’ll notice that lenders will give you both an Interest Rate and an Annual Percentage Rate. The difference between these two numbers is a continuing source of confusion among consumers.
· Your Interest Rate is the per year cost to borrow the money from the lender. It doesn’t matter if the rate is fixed or adjustable, and it does not include other fees charged to you by the lender.
· The Annual Percentage Rate (APR) includes the interest rate, broker fees, points you choose to pay and other items charged to you to get the loan. The APR is almost always higher than the interest rate.
The interest rate and loan balance are what determines your monthly mortgage payment. Because the APR includes loan fees charged by a lender, it’s often a much better tool for comparison shopping. It gives you a clearer picture of the overall cost of the loan. When you are shopping for lenders, ask what they include in their APR. The Truth in Lending Act was put in place by the Federal Government to protect consumers from unlawful credit practices. It requires lenders to disclose what fees make up their Annual Percentage Rates.
You should also be aware of unsolicited loan offers that sound too good to be true. Veterans are often considered easy pray for predatory lenders that try to lure you in with super-low interest rates that will balloon up after a period. Always be sure to do your homework and beware any offer that sound like easy money.
Locking Your Interest Rate
Once you choose your lender and go through the approval process, you can choose to lock in your interest rate. A lock holds your interest rate for a certain time period, usually 30 to 60 days. Lenders will often do this free of charge for an initial period, but if you want to hold the rate longer there is a charge to do so. On the surface, this sounds like a no brainer. However, there are some drawbacks. For one thing, if the rate goes down you would lose out on that lower interest rate. You also need to take into account how long it will take you to find a house. Often times, people choose to wait until they have a Purchase and Sale agreement, and then lock in the rate at that time. Do your research and see what the experts say. Talk to your lender as well. The more information you have the more confidant you’ll feel about your decision.
Forecasting Interest Rates
As of this writing in December of 2019, interest rates have been historically low – under 4%. They are forecasted to stay this way through December and early 2020, slightly rising
throughout the Spring. There is no shortage of websites that track interest rate trends and predict their movement over the next 6 to 12 months. Comparing the data from different sites will give you a solid general idea of where interest rates are heading. Some good sites to start with are FreddieMac, HSH and the Consumer Financial Protection Bureau
In the end, both internal and external factors influence interest rates. It can be confusing, but if you focus on finding the lowest interest rate paired with the perfect type of loan, you’ll be moving into your dream home in no time. Everyone’s circumstances are unique, so give one of our VA home loan specialists a call at 855-956-4040 for more information. We are here to serve you!