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FHA ARM Loan Basics

November 30, 2010

The FHA offers an adjustable rate mortgage, also known as an FHA ARM loan. These loans offer an introductory interest rate which is subject to change after the initial fixed rate period. That period varies depending on the loan–there are hybrid ARM loans available that feature different periods–but once the introductory rate period has elapsed, the adjustable rate is subject to a cap that applies either year-to-year or over the lifetime of the FHA loan.

The initial interest rate is often lower than the fixed rate of conventional home loans, which is why many people consider ARM loans even in spite of the fears generated by the housing crisis of 2008.

ARM loans have four components; the index, margin, interest rate cap and the initial interest rate. As mentioned above, the ARM loan has an intial interest rate. Once that rate expires, a new interest rate is obtained by adding the margin–the fixed portion of an ARM loan–to the index. When you apply for an FHA ARM loan, the loan officer will explain the margin, which vary from bank to bank. There is no standard margin.

The FHA explains how an FHA ARM loan works, stating “As the index figure moves up or down, your interest rate will be adjusted accordingly. Acceptable index options on FHA insured ARM loan transactions are 1) the Constant Maturity Treasury (CMT) index (weekly average yield of U.S. Treasury securities, adjusted to a constant maturity of one year); or 2) the 1-year London Interbank Offered Rate (LIBOR). Increases or decreases in the interest rate will be limited by the interest rate cap structure of your loan”

The FHA offers a standard one-year ARM loan guaranty with an annual interest rate cap of one percent, and life-of-the-loan interest rate cap of five percent up or down. FHA ARM Hybrid loans have different terms which we’ll cover in another blog post.

The appeal of an FHA ARM loan includes affordability for those who don’t expect to own the home very long, and it also appeals to those who know they have more income coming down the line to help pay for the higher interest rates where applicable.

An ARM loan interest rate is also capable of going down, which is what most FHA borrowers hope for when applying for ARM loans, but it’s not good to make financial plans counting on those interest rates going down. It’s best to assume the rates will likely increase and create a new budget with that in mind.

Joe Wallace - Staff Writer

By Joe Wallace

Joe Wallace has been specializing in military and personal finance topics since 1995. His work has appeared on Air Force Television News, The Pentagon Channel, ABC and a variety of print and online publications. He is a 13-year Air Force veteran and a member of the Air Force Public Affairs Alumni Association. He was Managing editor for www.valoans.com for (8) years and is currently the Associate Editor for FHANewsblog.com.

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