FHA ARM Rates Offer FHA Advantages At Lower Cost
FHA mortgages offer some great benefits. You can buy a home with just 3.5 percent down. The loan is assumable. FHA underwriting guidelines are among the most forgiving in the industry. And FHA ARM rates let you get these advantages for less.
How Do FHA ARMs Work?
The FHA Adjustable Rate Mortgage comes with an interest rate that can change (up or down) at regular intervals over the life of the loan.
This relieves the lender of some of the risk that comes with a fixed-rate mortgage — if rates in general rise significantly, but the borrower only has to pay a low fixed rate, the lender could lose money.
This is called interest rate risk. To get borrowers to accept some of this risk, FHA ARM rates are lower than those of fixed-rate mortgages.
FHA ARMs can be the right choice if you plan to own your home for only a few years. ARMs can also make sense when you expect an increase in future earnings, or when the “spread” between fixed and adjustable rates is large.
The 4 Parts Of An FHA ARM
Adjustable rate mortgages have four ingredients:
- Index
- Margin
- Start rate and period
- Rate cap structure
Index
The index is a published measurement, an interest rate that reflects global financial conditions. The ARM’s future interest rate changes are based on its index.
The Department of Housing and Urban Development (HUD) allows FHA ARMs based on either the Constant Maturity Treasury (CMT) index or the 1-year London Interbank Offered Rate (LIBOR).
The 1-Year CMT is an adjusted weekly average yield on U.S. Treasury Securities. The 1-Year LIBOR is published in the Wall Street Journal on the first business day of each week.
As of this writing, the CMT is .83 percent, and the 1-year LIBOR is 1.71 percent.
When your ARM begins resetting or adjusting, your new rate is determined by adding a margin to your loan’s index.
Margin
Your lender discloses its ARM margin when you apply for a mortgage. (Margins may vary between lenders and programs, so compare offers from several lenders to get a low margin).
As the index moves up or down, your interest rate adjusts. FHA ARM rates reset once a year. On the adjustment day, the lender sets your new rate by adding the index that day to the loan’s margin.
If, for example, you had a CMT ARM with a 2.5 percent margin, it would adjust (as of this writing) to 3.33 percent. That’s the LIBOR at .83 percent plus the 2.5 percent index.
However, that’t not all. The terms of the FHA ARM protect you from sudden spikes in your rate and payment that could make your loan un-affordable.
Start Rate And Period
The loan’s start rate is the interest rate you’ll pay during the first years of your mortgage. Depending on the loan, this rate is effective for periods of one, three, five, seven or ten years.
This start rate varies between mortgage lenders. Compare offers from several lenders to get the most competitive interest rate.
Most homebuyers will want to base their choice of loan and its initial rate period on the number of years they expect to keep the property or the mortgage. Once they have sufficient home equity, many people refinance to drop the required FHA mortgage insurance.
Cap Structure
After the initial period, the interest rate adjusts annually. The interest rate cap softens the effect of rapidly changing interest rates. There are two caps: annual and life-of-the-loan.
The annual cap limits the amount your interest rate can change from one year to the next. The life-of-the-loan cap sets the maximum and minimum interest rate you pay for as long as you have the mortgage.
Here are the different interest rate cap structures for FHA ARM products:
- 1- and 3-year ARM rates may increase by up to one percentage point annually after the initial fixed interest rate period. They can exceed the start rate by a maximum of five percentage points over the life of the mortgage.
- 5-year ARMs offer two options: they can increase by up to one percentage point annually, and five percentage points over the life of the Mortgage. Or they may allow increases of up to two percentage points annually and up to six percent over the life of the mortgage.
- 7- and 10-year ARM rates can increase by up to two percentage points annually after the initial fixed interest rate period. They are capped out at six percentage points over the start rate during the life of the loan.
If you have an FHA 3/1 mortgage at 2.25 percent, your rate could go to a maximum of 3.25 percent in Year Four, 4.25 percent and Year Five, and 5.25 percent in Year Six.
Its rate could never exceed 7.25 percent over the life of the loan.
What Are Today’s Mortgage Rates?
Current mortgage rates for FHA ARMs depend on the product you choose, your strength as a borrower, and how effectively you shop for your home loan.
You’ll want to pay attention to differences in the index, margin and cap structures between offers from mortgage lenders. Figure out how long you plan to keep your loan and / or property, and then look at what could happen to your mortgage rate and payment over that term.
