Reader question: “I’m thinking about using the FHA program to buy a house, because I don’t have much money saved up for a down payment. I might use a 3-year or 5-year ARM loan because I don’t think I will stay in this house for much longer than that. My question is, does FHA offer adjustable-rate mortgage loans, or just the fixed type?”
The short answer is yes, you can obtain an FHA loan with an adjustable rate assigned to it. The bigger question is whether or not it makes sense to do this. It sounds like you have it all figured out, for the most part. So let me connect the dots for other readers who may be less familiar with this topic. Let’s start with a couple of definitions.
Definitions: FHA Loan and Adjustable-Rate Mortgage
An FHA loan is simply a mortgage loan that is insured by the government through the Federal Housing Administration. It is this government-provided insurance that makes them different from conventional or “regular” loans. The insurance protects the lender in the event of borrower default (i.e., failure to pay).
An adjustable-rate mortgage has an interest rate that changes or adjusts periodically over time. Most of the ARM loans used today are “hybrid” loans that start off with a fixed interest rate for a certain period of time. For example, an FHA 5-year adjustable mortgage has a fixed rate for the first five years, after which it will begin to adjust each year. We will talk more about this hybrid concept below.
It’s not entirely accurate to say that the FHA offers adjustable-rate mortgages. In truth, the Federal Housing Administration does not provide loans at all. They simply insure the loans made by lenders that operate within the private sector.
You apply for this program through a bank, credit union, or mortgage lender that has been approved by the Department of Housing and Urban Development (HUD). Lenders must be approved by HUD before they can offer these loans to the public. The bottom line is that FHA mortgage loans are available with both fixed and adjustable rate structures.
How an FHA ARM Works
As mentioned earlier, the adjustable-rate mortgage gets its name from the way the interest rate behaves over time. An FHA ARM is simply an adjustable home loan that has been insured by the federal government. This makes it different from a conventional ARM that is either uninsured or insured by a private third-party company (PMI). It is the government’s involvement that makes the difference.
FHA adjustable-rate mortgages are available in several forms. For the most part, they all work the same. The difference lies within the length of the fixed-rate stage of the loan. Earlier, we talked about the “hybrid” concept in which the loan has a fixed rate for a certain period of time (such as three years), after which the mortgage rate begins to adjust every year. You can obtain an FHA ARM with an introductory stage of various lengths. The most common types are 3-year, 5-year, and 7-year. The number indicates the length of the fixed-rate phase. After that phase, each loan will undergo a rate adjustment every year for the remainder of the term.
The primary benefit of using an FHA adjustable-rate mortgage is that you can probably get a lower interest rate, when compared to a fixed-rate loan. But this is true only during the initial stage. For example, if you were to take out a 3-year FHA ARM loan, you would likely secure a lower rate during those first three years (when it remains fixed) than you might get with a traditional 30-year fixed loan.
This is the primary reason why people choose adjustable over fixed mortgages in the first place. You can save money by securing a lower interest rate. But this is only during initial fixed stage of the ARM loan. Once the rate starts to adjust, (whether it’s at the three, five, or seven-year mark), all bets are off. At that point, the ARM may actually become more expensive than a traditional 30-year fixed product, depending on how the interest rate changes over time. So there is an element of uncertainty with these products, over the long term.
Selling or Refinancing Before the Adjustments Begin
Most people who use adjustable-rate FHA loans either plan to sell or refinance the home within a few years. In such cases, it might make sense to use an ARM as compared to a traditional fixed-rate mortgage. If you can save money by securing a lower interest rate for the initial phase of the loan — and you can either sell or refinance before the rate starts adjusting — it could work out to your advantage. But you’ll notice there are two “if” statements in the previous sentence…
- The adjustable option is only advantageous if you secure a lower rate during the first phase of the loan.
- Additionally, if you don’t sell or refinance the home before the fixed-rate stage expires, you could encounter the uncertainty of a regularly adjusting interest rate. Your monthly payments could start to grow, year after year, for the remainder of the term.
In closing, let’s revisit the question at hand. Does FHA offer adjustable-rate mortgages? The Federal Housing Administration does not offer financing directly to the public. They merely insure loans made by lenders in the private sector. It’s important to understand this distinction.
When you apply for the FHA program, you’ll have the option of choosing between an adjustable or a fixed-rate home loan. The Federal Housing Administration will ensure either type, as long as it meets all of HUD’s minimum requirements.
So yes, FHA loans are available in adjustable rate form. In fact, the FHA arm loan is one of the most popular financing products used by home buyers today. Whether it’s the right product for you is a different question entirely. Consider the pros and cons discussed in this article to make an informed decision.