The government's consumer protection agency, The Consumer Financial Protection Bureau (CFPB), has a page on its official site explaining the differences between a fixed rate mortgage loan and an adjustable rate mortgages, sometimes known as ARM loans.
According to the CFPB, "The difference between a fixed rate and an adjustable rate mortgage, is that for fixed rates the interest rate is set when you take out the loan and will not change. With an adjustable rate mortgage, the interest rate may go up or down. With a fixed rate mortgage, the interest rate is set when you take out the loan and will not change".
Does the FHA single-family home loan program offer such a loan? Can borrowers apply for an FHA ARM loan with a participating lender?
Yes. Any participating lender choosing to offer FHA ARM loans can explain to you the basic terms and conditions of these loans and compare them with FHA fixed-rate mortgages. The FHA official site has a page dedicated to FHA-guaranteed ARM loans, which states in part:
"An ARM is an Adjustable Rate Mortgage. Unlike fixed rate mortgages that have an interest rate that remains the same for the life of the loan, the interest rate on an ARM will change periodically. The initial interest rate of an ARM is lower than that of a fixed rate mortgage, consequently, an ARM may be a good option to consider if you plan to own your home for only a few years; you expect an increase in future earnings; or, the prevailing interest rate for a fixed rate mortgage is too high."
How does an FHA ARM loan work? According to the FHA official site there are four components to an ARM loan you should understand. They are the:
1. index
2. margin
3. interest rate cap structure
4. initial interest rate period (also known as a "teaser rate" period)
Borrowers will be informed that the initial interest rate will expire at a certain date after the loan payments begin. Once the initial rate expires, the FHA official site states that a new interest rate is determined, "...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). As the index figure moves up or down, your interest rate will be adjusted accordingly."
The official site describes what the government considers to be "acceptable Acceptable index options" for FHA insured ARM loans. They include the following:
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.
The interest rate cap is designed to protect an FHA borrower from excessive changes in the interest rate. In an upcoming blog post, we will examine what the FHA says about the rate cap and how they work for different types of FHA ARM loans.
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