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When you buy a home with an FHA mortgage, you will choose between a fixed-rate mortgage where the payments stay the same for the duration of the loan term and an adjustable-rate mortgage where the rates may change after a certain period of time.

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How FHA Adjustable Rate Mortgages Work

June 10, 2022

How FHA Adjustable Rate Mortgages Work
When you buy a home with an FHA mortgage, you will choose between a fixed rate mortgage where the payments stay the same for the duration of the loan term and an adjustable rate mortgage where the rates may change after a certain period of time.

Borrowers choose an adjustable rate mortgage, also known as an ARM loan when the introductory rate is more competitive than the fixed rate loan option. These buyers may plan to sell before a rate adjustment, or after the first adjustment. ARMs are best for those who approach the loan with a strategy to deal with the rate adjustments. How do they work?

What follows are the FHA loan rules for FHA ARM loans. This information is not applicable to any ARM loan, these are the guidelines for the FHA Single Family Home Loan program.

How an FHA Adjustable Rate Mortgage Works

As mentioned above, the interest rate on an ARM will change after the introductory rate period ends. The FHA official site describes ARMs as having four components:
  • An index
  • A margin
  • An interest rate cap structure
  • An initial interest rate period. 
When the introductory rate period ends, a new interest rate is calculated. The new rate is found by adding a margin to the index. FHA loan rules say, “Increases or decreases in the interest rate will be limited by the interest rate cap structure of your loan.” You will need to discuss this cap with your lender and it pays to shop around and ask about details like these when doing so.

FHA ARM loan interest rate caps are meant to protect the borrower from major interest rate changes. There is an annual cap and a cap for the duration of the mortgage. FHA loans feature a 1-year ARM and four "hybrid" ARM options.

What’s a Hybrid ARM Loan?

 Hybrid ARM loans are designed with an introductory rate that does not change for a specified period. That may last for three, five, seven, or even 10 years before the rate changes. Once it does change it may be adjusted annually.
  • According to FHA loan rules. 1- and 3-year ARMs, “may increase by one percentage point annually” after the initial rate expires. These loans may increase “by five percentage points over the life of the Mortgage.”
  • 5-year ARMs may increase by one percentage point annually, and five percentage points over the life of the Mortgage. They may also be structured to increase by two percentage points annually, and six points over the term of the loan.
  • 7- and 10-year ARMs increase by two percentage points annually after the initial rate period expires. These loans are capped at six percentage points over the life of the loan.
Adjustable rate mortgages aren’t a good option for every home buyer. You’ll need to examine your financial needs and goals to determine whether a fixed rate loan or an ARM loan is the right choice based on how long you plan to stay in the house you buy with the FHA loan.

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