So you might be asking what determines if my interest rate goes up. Well it’s completely based on what market rates are doing. When you get a fixed rate part of the risk for the lender (or investor that will eventually buy the loan) is they are agreeing to allow you tie up their money for the duration of the loan at a set rate of interest.
Think about it…if I let you borrow money today at 4% interest for 30 years and ten years from now market rates are 8%, I’ll be losing a considerable amount of profit on the money I have tied up in your loan.
This is why lenders give you a break on the initial interest rate when you get an ARM loan. It reassures them that in the future if market rates increase they’ll be able to adjust your rate accordingly and enhance their profits.
So the determining factor for your interest rate will be the index and the margin. The index is what your loan tracks. We don’t need to get too deep into the weeds, but just know that VA ARM rates are based on the one, three, or five year treasury securities (also known as the T-Bill).
In addition to the yield for the T-Bill, lenders will also charge a margin. A margin is what they add to the T-Bill yield to determine what your rate will be, it is also the source of their profits. Your margin will never change, but the index will move everyday.
Once a year, after your fixed period ends the lender will look at the margin. Then they'll adjust your rate accordingly, and recalculate your payment based on the amount of time you have left on the loan and the amount that you owe.
It’s really that simple. Your rate will go up and down as the index goes up and down. However, the caps are in place to ensure that if there’s spikes in the market your rate and payment adjusts at a milder pace than what may be happening in the market place.