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An FHA Adjustable Rate Mortgage also known as an "ARM" is a mortgage that does not have a fixed interest rate. This means that the interest rate of the mortgage fluctuates periodically. The beginning interest rate of an FHA Adjustable Rate Mortgage is known as the "Initial Interest Rate Period" and is lower than the FHA Fixed Rate Mortgage. One option is to get an Adjustable Rate Mortgage that starts with a much lower beginning rate and pay the lower interest rate for several years than simply refinance into an FHA Fixed Rate Mortgage. Also, if you're planning on only owning your home for a short amount of time, and Adjustable Rate Mortgage is probably your best option since the initial interest rate is much lower.
The idea behind an FHA Adjustable Rate Mortgage is that the borrower plans on having an increase in income within the next few years. So you get an Adjustable Rate Mortgage while your income is lower and the interest rate, then by the time your rate increases you will have a higher income and can easily afford the mortgage. If not you can try your chances at getting a FHA Fixed Rate Mortgage that has a rate which is lower than that of your new interest rate increase.
The Adjustable Rate Mortgage Components
Note: Your lender must disclose all 4 components of your FHA Adjustable Rate Mortgage at the time of your loan application.
1. The Index - The index of an FHA Adjustable Rate Mortgage is the variables that defines whether your Adjustable Rate Mortgage will go up or down. The Index is also known as the Constant Maturity Treasury Index, which is a weakly average yield of the U.S. Treasury securities adjusted to a constant maturity of 1 year.
2. The Margin - This is the margin or percentage of increase that your interest rate will see when the initial low interest rate period is complete. When getting an FHA Adjustable Rate Mortgage you always want to make sure that you're getting the lowest margin possible.
3. Interest Rate Cap Structure - There are 2 cap types, annual and life of loan. The annual rate cap defines how much your interest rate can go up within one years time. The life of loan defines the highest your interest rate may go up through out the life of your loan term.
4. Initial Interest Rate Period - Your initial rate period is the beginning interest rate of your mortgage. This is the low interest rate that you get when you first start the term of your loan. FHA offers 5 different types of Adjustable Rate Mortgages.
- 1-year ARM and 3-year hybrid ARM have annual caps of one percentage point, and life-of-the-loan caps of five percentage points. (Example - if your initial interest rate were 5.00%, the highest possible interest rate would be 10.00%)
- 5-, 7-, and 10-year hybrid ARM have annual caps of two percentage points, and life-of-the-loan caps of six percentage points.
Benefits of an FHA Adjustable Rate Mortgage
As will all FHA Loans, an FHA Adjustable Rate Mortgage follows the same requirements for qualification. View FHA Requirements for more on what it takes to get into an FHA Loan. The Adjustable Rate Mortgage has several benefits...
- If you currently have a hard time affording an FHA Fixed Rate Mortgage, but know that you will be having an increase in income within the next few years you can still get into your own home and feel comfortable with the payments. You also always have the fall back option of refinancing into a Fixed Rate Mortgage if your rate increase goes beyond what you're comfortable with.
- If you're planning on living in the home for set amount of years you can usually find the "hybrid" ARM that can meet the amount of years you'll be in the home. Therefore you can have a low initial interest rate for the length of time you plan to be in your home. For example, let's say that you're planning on moving in 3 years, but don't want to pay for the higher rate of a Fixed Rate Mortgage, you could get into an FHA Adjustable Rate Mortgage with a 3-year hybrid ARM. This means that you will have the low Adjustable Rate Mortgage for the life of your residency.
- You can always do an FHA Streamline from an FHA Adjustable Rate Mortgage into and FHA Fixed Rate Mortgages, although the rate cannot increase more than 2% and the mortgage payment cannot increase more than 20%.
