FHA ARM: Great Alternative For Many Home Buyers Part 1

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FHA ARM Rates

FHA Adjustable Rate Mortgages (ARMs) have always held an important place in the mortgage product spectrum. They have faded a little in popularity in the current era of historically low fixed rates but they still have a place in today’s market. ARMs have traditionally had lower rates than fixed rate mortgage products and this remains true even in this market. They allow a borrower who does not need the security of a fixed rate mortgage to get the benefit of lower rates and the cash flow advantage afforded by these lower payments. While not the right product for all scenarios, the ARM is still a great alternative for many borrowers. With that said it is also important to note that there are some very strong FHA ARMs available out there that not only have all of the advantages of a fixed FHA mortgage (low downpayment, expanded credit criteria, etc.) but have very strong ARM terms and great rates.

What is an FHA ARM?

First a quick primer on Adjustable Rate Mortgage products in general: ARMs are mortgage products that have a fixed rate for a set number of years and then begin to adjust (typically once a year) for the remainder of the term of the mortgage. The fixed term of these loans can vary; 3/1 ARMs have a fixed rate for 3 years, 5/1 Arms are fixed for 5 years, 7/1 fixed for 7 years and so on.

FHA ARM Rate
How much an FHA ARM rate can adjust at the end of the fixed period is based on a ‘Margin’ that is established at the beginning and will not change through the life of the loan and an ‘Index’ which is ever changing. On most ARM loans the ‘Index’ used is typically either the 1 yr T Bill (CMT) or the 12 month LIBOR. There are products that use other indexes but the vast majority of ARMs are tied to these two. At the end of the fixed period the Margin is added to the current Index and this sum is the new rate for the next 12 months.

FHA ARM Rate Caps
This ‘new’ rate is subject to ‘Caps’ set forth at the beginning of the mortgage that establish maximum amounts the rate can adjust in any one period and over the life of the loan. On traditional ARMs sold by Fannie Mae and Freddie Mac (Agency ARMs) these Caps are in the 2%-6% range. FHA ARM Caps are typically set with 3 numbers relayed in a format that outlines the first adjustment cap/life cap. So with an ARM that has Caps of 5/2/5, the rate can adjust up to 5% in the first adjustment period, 2% every year thereafter, and has a lifetime cap of 5%. As you can see the combination of favorable Margin, Index and Cap terms will often be the determining factors when considering an ARM.

Continue to Part 2: FHA ARM: Great Alternative For Many Home Buyers Part 2

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