What’s the difference between a fixed-rate mortgage and an adjustable-rate home loan? FHA single-family home loans come in a variety of types including both fixed-rate loans and those with adjustable rates. The rules for these loans, commonly referred to as FHA ARM loans, are spelled out in HUD 4000.1, the FHA Lender’s Handbook.
Fixed rate home loans backed by the FHA are essentially what their name implies; a mortgage with a rate negotiated between the borrower and lender that does not change for the entire loan term.
Borrowers who later want to apply for a lower rate can apply for FHA refinancing including options such as the FHA Streamline Refinance loan program for FHA-to-FHA refinances or the FHA cash-out or no-cash-out refi loan for non-FHA mortgages.
Yes, you read that correctly, FHA loans can be used to refinance a non-FHA mortgage.
FHA adjustable-rate mortgages (ARMs) feature an initial opening rate (usually lower and sometimes referred to as a “teaser rate” because the interest will be adjusted once that introductory rate expires. These adjustable-rate loans are often different than their conventional counterparts.
What kind of differences? For starters, there are FHA-imposed restrictions on how often the interest rate may change and by how much.
The FHA loan rules begin by defining what an FHA ARM loan is:
“An Adjustable Rate Mortgage (ARM) refers to a Mortgage in which the interest rate can change annually based on an index plus a margin.”
Your loan officer is required to provide a disclosure form, which must be signed, that fully explains the terms of an FHA adjustable rate mortgage. Informed borrowing is an important part of any home loan, but where ARM loans are concerned the borrower should fully understand how such lending works.
According to HUD 4000.1, the lender must establish the initial interest rate. The lender also establishes a margin for the loan which must be constant, according to FHA loan rules, for the entire mortgage.
And what about the changes in interest rates on the FHA ARM? The initial rate must be consistent for an initial time frame from a single year up to as many as ten years.
Once the initial rate period has expired, the rate may be subject to changes for “the remainder of the mortgage term” according to the FHA loan handbook, but with restrictions.
According to the FHA official site, one-year and three-year FHA adjustable rate loans “may increase by one percentage point annually after the initial fixed interest rate period, and five percentage points over the life of the Mortgage”.
That kind of predictability will help you determine whether an FHA ARM loan is the right kind of mortgage product for you.
Consider the adjustment rules for the five-year version–such loans “may either allow for increases of one percentage point annually, and five percentage points over the life of the Mortgage; or increases of two percentage points annually, and six points over the life of the Mortgage”.
And then there are the seven-to-10 year FHA adjustable rate mortgages where the interest rate “may only increase by two percentage points annually after the initial fixed interest rate period, and six percentage points over the life of the Mortgage”.
The fixed-rate mortgage and the adjustable-rate mortgage both have one important thing in common–neither type of FHA mortgage is permitted to apply a penalty for early payoff of the loan. Talk to your lender about your financial needs and you can determine which option might be best for you.