December 8, 2022

FHA Adjustable Rate Mortgages (ARM) Offer Benefits and Risks

The FHA offers a variety of adjustable rate mortgages.  An adjustable rate mortgage is known as an ARM and the rate will vary over the life of the loan.  A fixed rate FHA mortgage has a rate that remains unchanged for the life of the loan.  The rate on an ARM is lower than a fixed rate FHA mortgage.   There are benefits but also risks associated with an ARM.

There are different scenarios under which it makes more sense to take an FHA ARM instead of a fixed rate mortgage.  An FHA ARM should be considered as the better option under the following circumstances.

  1. The borrower expects to remain in the home for only a short period of time.  Since the FHA ARM rate is lower than the fixed rate, a borrower would pay less in interest charges.
  2. The borrower wants to have a more comfortable monthly budget and expects that his future income will increase.  The ARM allows the borrower to have a lower current payment.  Since the borrower expects to have higher future income, if the rate on the ARM later increases, the risk of payment shock from a higher monthly mortgage payment is reduced.
  3. The borrower is buying or refinancing a home when fixed interest rates are too high.  An FHA ARM would allow the borrower to get a lower rate adjustable loan that can be refinanced to a fixed rate when mortgage rates decline.

The FHA offers adjustable rate mortgages on which the rate can change after 1, 3, 5, 7 or 10 years.  Selecting the one that makes the most sense is often complicated.  The borrower should ask the lender to explain how the different ARM products work and provide examples of how much the monthly payment could change when the rate adjusts.  (See Factors That Affect Rate Changes On FHA ARM Mortgages.)

The ARM that does not adjust for a longer period of time will have a higher rate than a shorter term ARM.  For example, a borrower taking out a 7 year ARM would not have to worry about a change in the rate until after 7 years.  However, the initial rate on the 7 year ARM will be higher than on an ARM product with a shorter initial rate adjustment period.

The FHA ARM products protect the borrower by limiting the amount that the interest rate can change after the initial interest rate changes.  The borrower is also protected by caps on how much the interest rate can change over the life of the loan.

The FHA does not offer interest only mortgages, either fixed or adjustable, so regardless of which product a borrower selects, the monthly payments on both a fixed rate and adjustable rate mortgage will result in a reduction of the borrower’s loan balance.

A borrower should keep in mind that the FHA adjustable rate mortgage is much more complex than a fixed rate mortgage.  Before deciding to go with an FHA ARM, the borrower should fully understand how by how much and when the rate can change as well as the manner in which rate changes are calculated.   (See Different Types of FHA ARM Mortgages.)