Some borrowers decide an adjustable rate mortgage is an option they’d like to look into. While there is a natural risk involved with adjustable rates–the interest rate can increase and raise the amount of monthly payments–borrowers who shop around and compare terms may be able to get into an adjustable rate mortgage that has more favorable terms. It’s a smart idea to go into an adjustable rate mortgage with the notion that you should refinance later into a fixed rate loan.
The FHA streamline refinancing program has a way to do just that for those who have FHA ARM loans. Other refinancing options may be available for conventional-to-FHA loans, we’ll explore refinancing issues in another blog post.
What should a borrower do to find the best adjustable rate mortgage? To start, comparing conventional loans to each other and to the terms of FHA ARM loans is strongly recommended. How do the terms and conditions measure up?
ARM loans have four areas to study; the an index, the margin, the initial interest rate period, and finally the structure of the interest rate cap where applicable. The initial interest rate period often features an introductory rate that will go up when that period ends. How high or low is that introductory rate? How long does it last? When the new interest rate is calculated, how high will it be potentially?
According to the FHA, the new rate “is calculated by adding a margin to the index. Your lender will disclose the margin at time of loan application (margins may vary from lender to lender, so it’s is a good idea to shop around for a low margin). As the index figure moves up or down, your interest rate will be adjusted accordingly.”
A very important aspect of any ARM loan you should compare–how high and how often the interest rate is re-calculated. FHA loans feature interest rates that are constant for the first three to ten years depending on the loan. After that initial period the interest rates are adjusted once per year and have interest rate caps that also vary from loan to loan. Some have caps of one percentage point, with lifetime-of-the-loan limits of five percentage points.
How do such caps and adjustment periods compare to the conventional equivalents? Do you get any similar protection from increased interest rates with the conventional equivalents? These are important things to have answers to before committing to an adjustable rate mortgage. Contact the FHA for more information on ARM loans and your options.