FHA Loans – ARM


The FHA adjustable rate mortgage (or ARM) is different than the conventional or jumbo ARMs. It offers better features with lower adjustments than a conventional or jumbo ARM. It still has a fixed period of time that the interest rate will not change and can adjust periodically after the initial fixed period expires. These mortgages are also backed up by HUD.

Guidelines and Parameters

An ARM has two components—the first number represents how long the interest rate will remain fixed, or will not change for that period of time of the loan. The second number tells you the length of time and frequency the loan will adjust once the variable portion kicks in. FHA ARMs use predetermined caps and margins that work in concert with monetary fund indexes to establish the interest rate when the loan adjusts.  FHA adjustment caps vary greatly when compared to Conventional or Jumbo loans as those caps and margins are usually much lower.  Currently the FHA offers only one ARM type:

5/1 ARM: Your interest rate is set for 5 years then adjusts for 25 years.


Who Is It Right For?

The FHA ARMs are ideal for homebuyers who:

  • Have less than perfect credit history
  • Do not have the typical 5% down payment required to qualify for a conventional loan.
  • Expect their income to increase in the next couple of years and are using the lower ARM rate to qualify now for a mortgage.
  • Understand that their rate may increase after the initial period.
  • Don’t anticipate holding on to the property for the full term of the mortgage.
  • Want the benefit of a lower initial rate and monthly payment.

Features

This special mortgage program utilizes the benefits of an adjustable rate conventional loan outlined previously, with increased loan amounts for higher priced properties. Based on county limits these loans can go above the traditional limits but stay below Jumbo loans, with a maximum of $625,500 in many counties.

FHA adjustable rate mortgages have predetermined limits for the periodic and lifetime caps when the loan reaches its adjustable stage.

All ARMs contain these first three features.

An adjustment schedule

This schedule is indicated in the mortgage contract and changes in the rate charged on an ARM loan—occurring at the end of each adjustment period. Adjustment periods occur in equal intervals depending on the kind of ARM selected (1 year, 3 year, 5 year, etc.).

Index

Every ARM is linked to an index that increases or decreases in tandem with the overall movement of interest rates. The index is what’s used to determine the new loan rate for each adjustment period.

An adjustment margin.

While the loan rate and index rate move together they are not the same. The margin is the percentage amount that a lender adds to the index rate when calculating an ARMs new interest rate at each adjustment period.

Qualifying for an ARM

Qualifying for an adjustable rate mortgage may vary based on the term of the ARM that you choose.  Speak to one of our mortgage experts for more information on this and the programs it affects.

Fixed Rate

Pros

  • Predictability. Homebuyers know how much interest there is to pay over the term of the loan.

 

  • Monthly payment is fixed and in early years consists primarily of tax-deductible interest.

 

  • Mortgages without prepayment penalties permit homebuyers to shorten the term of the loan at will by making periodic payments against principal—and, ultimately, lowering interest costs.

Cons

  • Stability comes with a price; interest rates on fixed rate loans are generally higher than starting rates on ARMs.

 

  • If you choose a low down payment option you may have to pay for mortgage insurance, which adds an additional monthly fee to protect the lender from risk of loss.

Adjustable Rate Mortgage

Pros

  • Lower initial rate and payment amount, this means you may be able to buy a larger home than you originally believed.

 

  • If mortgage rates fall borrowers need not refinance to take advantage of them, instead they are automatically lowered.

 

  • If borrowers choose an ARM and save money it creates a way to invest more. If a borrower saves $100 a month in an account rather than putting it towards a mortgage payment it yields a higher investment interest.

 

  • If a borrower does not plan on living in one place for long an ARM can offer an inexpensive way to purchase a home.

Cons

  • Rates and payments can increase drastically over the life of the loan. A 6 percent ARM could end up at 11 percent in just three years if rates continually increase.

 

  • The initial adjustment can come as a surprise.

Long Term

Pros

  • Predictability. Homebuyers know how much interest there is to pay over the term of the loan.

 

  • Monthly payment is fixed and in early years consists primarily of tax-deductible interest.

 

  • Mortgages without prepayment penalties permit homebuyers to shorten the term of the loan at will by making periodic payments against principal—and, ultimately, lowering interest costs.

Cons

  • This stability comes with a price; interest rates on fixed rate loans are generally higher than starting rates on ARM’s.

 

  • If you choose a low down payment option you may have to pay for mortgage insurance, which adds an additional monthly fee to protect the lender from risk of loss.

Short Term

Pros

  • Principal balance is reduced relatively rapidly.

 

  • compared to longer-term loans.

 

  • Permits outright home ownership in half the time with half the cost of interest of a 30-year fixed.

 

  • May have lower interest rates than a 30-year fixed and therefore offers a useful financial planning tool.

Cons

  • Higher monthly payments than those on a 30-year fixed make these loans more difficult to qualify for.

 

  • Choosing a loan with a shorter amortization period reduces the number of homes an individual can afford to buy.

 

  • Monthly payments are roughly 15%-30% higher than they would be on a comparable 30-year fixed.

Bi-weekly fixed rate

Pros

  • Biweekly payment schedule speeds up amortization, interest costs, and shortens the loan term generally to between 18 and 22 years. Homeowners make 26 biweekly payments (13 annual).

 

  • Conversion to a 30 year fixed is generally permitted.

 

  • Lowers interest expense.

Cons

  • There is generally an additional charge for this service thus making it a very costly way to shorten the life of the loan and lower the interest expense.

 

  • The same effect can generally be achieved by obtaining a 30 year fixed mortgage and simply making an additional payment or two each year or by applying an additional sum to principal repayment when homeowners make a monthly payment.

 

  • As with other rapid-payoff mortgages homeowners trade total interest-cost reductions for reduced tax benefits.

FHA

Pros

  • Low down payment requirements to obtain loan easing the burden of qualifying.

 

  • The funding fee for an FHA mortgage can be included with the mortgage.

 

  • Less than perfect credit history allowed for FHA loans.

Cons

  • PMI (Private Mortgage Insurance) is required on every FHA loan regardless of the down payment or equity in a property.

 

  • FHA loans have a 1.75% funding fee that gets added to the amount borrowed.

 

  • FHA rates can go up to account for lower credit scores.

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