The Veterans Benefits Act of 2002 authorizes VA to carry out a demonstration project to guarantee Hybrid Adjustable-Rate Mortgages (Hybrid ARMs) during Fiscal Years 2004 and 2005. This has now been extended to September 30th, 2012.

The VA is authorized to guarantee Hybrid ARM loans that close on or after October 1, 2003.
Hybrid ARMs will specify an initial rate of interest that is fixed for a period of at least 3 years. After that the rate can be adjusted annually. Annual adjustments are limited to 1 percent, and the maximum increase in the interest rate over the life of the loan is capped at 5 percent. Further details are:

The index for VA Hybrid ARM will be the same as that used by HUD which is the weekly average yield on U.S. Treasury securities adjusted to a constant maturity of 1 year.
VA will not dictate what margin lenders must use when processing Hybrid ARM loans. It's expected that market forces will determine what the appropriate margin should be.
Interest rate adjustments must occur on an annual basis, except that the first adjustment may occur no sooner that 36 months from the date of the borrower's first mortgage payment.

The lender is required to explain the nature of the obligation to the borrower in writing at the time of loan application. The borrower must certify that he or she fully understands the obligation. A copy of the signed certification should be retained as part of the loan origination package. The lender disclosure must include:

The fact that the mortgage interest rate may change, and an explanation of how changes correspond to changes in the interest rate index;
Identification of the interest rate index, its source of publication and availability;
The frequency (i.e., annually) with which interest rate levels and monthly payments will be adjusted, and the length of the interval (36 months) that will precede the initial adjustment;
A hypothetical monthly payment schedule that displays the maximum potential increases in monthly payments to the borrower over the first 5 years of the mortgage, subject to the provisions of the mortgage instrument.

VA Hybrid ARMs will be underwritten at the note rate. Because the interest rate on VA's Hybrid ARM loan will remain fixed for at least 3 years, there is no need to underwrite at a higher rate in anticipation of a possible rate increase within 12 months, which would be possible under the traditional 1 year ARM.

Lenders may not use temporary buydowns in connection with Hybrid ARMs.

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