March 3, 2015
In our last blog post we began discussing FHA adjustable rate mortgages, also known as ARM loans. We talked about how an FHA ARM loan works:
“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 time of loan application (margins may vary from lender to lender, so it’s a good idea to shop around for a low margin).”
We also mentioned the adjustable nature of the interest rates on these loans. “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.'”
But there are caps on how much the interest rate can change on an FHA ARM loan. How do these caps work? According to the FHA official site, the rate cap offers the borrower protection from a large amount of variation in the rate.
“There are two types of caps: (1) annual, and (2) life-of-the-loan. The annual cap restricts the amount your interest rate can change, up or down, in any given year, while the life-of-the-loan cap limits the maximum (and minimum) interest rate you can pay for as long as you have the mortgage. FHA offers a standard 1-year ARM and four “hybrid” ARM products. Hybrid ARMs offer an initial interest rate that is constant for the first 3-, 5-, 7-, or 10 years. After the initial period, the interest rate will adjust annually. Below are the different interest rate cap structures for the various ARM products:
- 1-year ARM and 3-year hybrid ARM have annual caps of one percentage point, and life-of-the-loan caps of five percentage points. (Example – if your initial interest rate was 5.00%, the highest possible interest rate would be 10.00%)
- 5-, 7-, and 10-year hybrid ARMs have annual caps of two percentage points, and life-of-the-loan caps of six percentage points.”
It’s very important to note that the information given above does not necessarily apply to ALL adjustable rate mortgage loans, only those guaranteed by the FHA.
Do you have questions about how FHA loans work? Ask us in the comments section. All questions and comments are reviewed prior to being posted on the website.
Joe Wallace has been specializing in military and personal finance topics since 1995. His work has appeared on Air Force Television News, The Pentagon Channel, ABC and a variety of print and online publications. He is a 13-year Air Force veteran and a member of the Air Force Public Affairs Alumni Association. He was Managing editor for www.valoans.com for (8) years and is currently the Associate Editor for FHANewsblog.com.
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