FHA adjustable-rate mortgages: What they are and how they work

This article is for educational purposes only. JPMorgan Chase Bank, N.A., does not offer an FHA adjustable-rate mortgage (ARM). Any information described in this article may vary by lender.

Quick insights

• The Federal Housing Administration (FHA) insures adjustable-rate mortgages (ARMs) with appealing approval criteria and loan terms.
• ARMs typically include an introductory period with a lower fixed rate before transitioning to an adjustable-rate structure (with an interest rate that periodically updates).
• To get an FHA ARM loan, you will need to meet all eligibility requirements and apply with an FHA-approved lender who can fund your loan.

Does the FHA offer ARM loans? In short, the answer is yes. FHA loans generally have more lenient approval requirements than conventional loans, smaller down payments and interest rates as low as 3.5%.ec-fha-loans-oct-2024 Although a fixed rate is common with this loan type, some people choose to pursue an FHA adjustable-rate mortgage (ARM) instead. For each loan, the interest rate will adjust annually after the initial rate period.

In this article, we’ll further explain how FHA ARMs work, including how rates are calculated and potential considerations.

How do FHA ARM loans work?

Most ARM loans have an initial fixed period before the adjustable rate kicks in. While this fixed term can vary, typical periods include 1, 3, 5, 7 or 10 years. After the adjustable-rate period begins, rates are typically updated on an annual basis. Factors that contribute to the rate for an ARM include:

• Index: Usually, ARM mortgages rely on a standard financial index rate (such as the Treasury index) to align their rates with present economic conditions.
• Margin: The “margin” on an ARM is a set percentage added by the lender to determine the total interest rate. One way to think about this addition is as a service fee for the loan.
• Rate cap: As a protective feature, most ARMs have a limit on how much the interest rate can increase on the loan. A rate cap can apply to both individual adjustment periods and over the lifetime of a loan.

With an FHA ARM loan, your lender will notify you when it's time for a rate adjustment, allowing you to prepare for the change. The new rate will then be factored into upcoming monthly payments, which can result in a different monthly total.

Types of FHA ARM loans

The FHA generally offers several ARM loans with specific interest rate cap structures:ec-adj-rate-mort-april-2025

• 1- and 3-year ARMs: Could increase by one percentage point each year after the initial fixed rate period, up to five percentage points over the loan term.
• 5-year ARMs: May allow for increases of one point annually and five points over the life of the loan, or increases of two percentage points annually up to six points over the whole loan term.
• 7- and 10-year ARMs: May increase by only two percentage points annually after the initial period, up to six percentage points.

Pros and cons of FHA ARMs

When considering how an FHA ARM might work for you, you may want to weigh the potential advantages and disadvantages. For a typical borrower, the possible benefits include lower initial payments with the potential for decreasing rates. The potential risks include rising rates (leading to higher costs) and added complexity.

Benefits of FHA ARMs

• Lower initial payments: ARMs often have lower rates during the fixed-rate period of the loan, which may be advantageous for a new homeowner.
• Potential for decreasing rates: Because ARMs adjust over time with fluctuations in the market, your interest rate may be lower at different times throughout your repayment.
• FHA backing: FHA loans (both fixed-rate mortgages and ARMs) are insured by the U.S. government, which can make it easier to qualify for the loan, potentially with better terms. Qualifications can vary by lender.

Risks of FHA ARMs

• Variable interest rate: While rates may potentially decrease with an FHA ARM, they could also increase. This would likely increase the amount of monthly payments.
• Complexity of terms: Depending on someone’s experience, the terms that come with an adjustable-rate mortgage, including various timelines, may seem complicated.
• Potential for negative amortization: If interest rates increase sharply, you may end up owing and paying more on your mortgage than before, potentially including more than the home is worth.

Buyers who may want to consider an ARM

You may be wondering what type of borrower would prefer an ARM over the consistency that comes with a fixed-rate loan. While fixed-rate loans are popular for their consistency, certain individuals may find the trade-offs worth the benefits, such as:

• Budget-conscious homebuyers: FHA loans are generally geared toward hopeful homebuyers with specific finances. With an FHA ARM specifically, the initial monthly payments may be lower, which can help homebuyers adjust to the responsibilities of homeownership more gradually.
• Borrowers expecting income growth: Those who anticipate income or career growth in the coming years may benefit from an ARM. This could include professionals working toward an advanced degree, those pursuing promotions or households with a temporary stay-at-home parent who will eventually return to work.
• Short-term homeowners: A buyer with plans to move or refinancerefinance-hl000061 in the future may choose an ARM, as they may be able to benefit from the lower introductory rates without ever seeing the adjustable period. Keep in mind that the act of refinancing includes certain closing costs, which may offset the lower introductory rates of an FHA ARM.

How can I get an FHA ARM loan?

Although these loans are backed by the federal government, you will need to work with an approved lender who can fund the loan. FHA-approved lenders are the entity you will deal with directly if you decide to pursue an FHA loan, including application, funding and repayment steps. Each approved lender may have their own processes and requirements relating to FHA loans, so be sure to examine each for specific information.

In conclusion

An FHA ARM has a different structure from most mortgages. With a fixed-rate loan, the interest rate remains the same throughout the total repayment, unless you choose to refinance. With an ARM, the rate adjusts with the market, resulting in payments of different sizes throughout its repayment. While FHA ARMs have certain advantages, some may view this type of loan as too risky or difficult to manage. It’s important to assess your own financial needs and preferences as you consider the type of mortgage that will work for you.