October 7, 2022
There are many types of different FHA loan products. You can apply for new purchase home loans, refinance loans, and even Home Equity Conversion Mortgage loans (HECM). But even with this variety of options to choose from, did you know you can apply for purchase or refinance loans guaranteed by the FHA that have adjustable interest rates?
It’s true–the FHA Single-Family Home Loan program offers both fixed-rate mortgages and adjustable rate home loans. The FHA official site has an entire page dedicated to Adjustable Rate Mortgages (also known as ARM loans).
Here’s how the FHA/HUD official site defines the ARM Loan:
“An ARM is an Adjustable Rate Mortgage. Unlike fixed-rate mortgages that have an interest rate that remains the same for the life of the loan, the interest rate on an ARM will change periodically.”
The initial interest rate, also known as a teaser rate, may be offered at a more competitive rate than that of a fixed-rate mortgage. An ARM may be a good option to consider if, according to the HUD official site:
- You plan to own your home for only a few years;
- You expect an increase in future earnings;
- The prevailing interest rate for a fixed rate mortgage is too high.”
As the FHA official site says, if you purchase now but know you don’t plan to be in the home long-term, an ARM might be a very good choice.
So how do FHA ARM loans work? From the official site:
“An ARM has four components: (1) an index, (2) a margin, (3) an interest rate cap structure, and (4) an initial interest rate period.”
When the initial interest rate period has expired, “the new interest rate is calculated by adding a margin to the index. Your lender will disclose the margin at the time of loan application (margins may vary from lender to lender, so it’s a good idea to shop around for a low margin).”
As the index figure moves up or down, the FHA official site says a borrower’s 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 interest rate cap is an important feature of the FHA ARM loan, this is what keeps the rate from being adjusted too much. We’ll examing how FHA ARM loan rate caps work in another article.