Editor’s note: This article outlines the basic requirements for FHA adjustable-rate mortgages. It is intended for lenders and borrowers alike. We also have a consumer-friendly overview that explains how ARM loans work, their pros and cons, etc. If you’re not familiar with these products, you might want to start with the overview.
The Federal Housing Administration (FHA) loan program allows for both fixed and adjustable-rate loans. In this article, we will look at some of the guidelines and requirements for FHA adjustable-rate mortgages (ARMs) in particular.
The following information is based on the latest guidelines outlined in HUD Handbook 4000.1, also known as the Single-Family Housing Policy Handbook. The portion of the handbook that explains ARM loan requirements took effect in September 2015. So it applies to all FHA adjustable-rate mortgages originated in 2016, unless revised or superseded by a HUD policy change.
FHA Adjustable Rate Mortgage Guidelines
The handbook starts with a simple definition. An adjustable rate mortgage (or ARM) is a home loan with an interest rate that can change annually based on an index plus a margin. The index and margin are explained in more detail below.
The Department of Housing and Urban Development (HUD) allows two indices to be used with FHA ARM loans. They are the Constant Maturity Treasury (CMT) index, and the 1-year London Interbank Offered Rate (LIBOR).
The 1-Year CMT is the weekly average yield on U.S. Treasury Securities, adjusted to a constant maturity of one year published in the Federal Reserve Board’s Statistical Release H.15 (519). The 1-Year LIBOR is published in the Wall Street Journal on the first business day of each week.
The margin is a fixed interest rate that the lender adds to the index, to arrive at the actual assigned mortgage rate for an FHA ARM loan. The index plus the margin equals the rate the borrower actually pays, in most cases. Margins can vary from one lender to the next, so it pays to shop around for a lower margin.
We’ve provided a list of FHA documents elsewhere on this website. Most of the documents on that list apply to both fixed and adjustable-rate mortgages. For an FHA ARM loan, there’s an additional disclosure document that is required.
According to HUD guidelines, borrowers must also read and sign a disclosure that explains the terms of the ARM. This is to ensure that the borrower understands how the loan works, and how the rate might change over time. Among other things, this disclosure explains:
- How the interest rate and payments are determined
- How the rate and payment can change over time
Obviously, these are two very important considerations from a borrower’s perspective. That’s why they are part of the FHA adjustable-rate mortgage disclosure requirements.
Interest Rate Increases for ARM Loans
The Mortgagee (i.e., mortgage lender) must establish the initial interest rate and the margin that will be applied to the ARM loan. According to HUD, the margin must remain constant for the entire term of the mortgage.
The interest rate must remain constant (and unchanging) for an initial period of 1, 3, 5, 7, or 10 years. The exact length of this initial period will depend on the ARM program chosen by the borrower. After the initial fixed-rate period has passed, the interest rate may change annually for the remainder of the mortgage term.
When it comes to interest rate increases after the initial period, there are different rules and requirements for the different types of FHA ARM loans. The HUD handbook states the following:
- The interest rate on a 1- and 3-year adjustable-rate mortgage may increase by one percentage point annually after the initial fixed interest rate period, and five percentage points over the life of the loan.
- The rate on a 5-year FHA adjustable mortgage / ARM may either allow for increases of one percentage point annually, and five percentage points over the life of the Mortgage; or increases of two percentage points annually, and six points over the life of the Mortgage.
- The interest rate assigned to a 7- and 10-year ARM may only increase by two percentage points annually after the initial fixed-rate period, and six percentage points over the life of the loan.
Note: The FHA adjustable interest rate requirements above were taken directly from HUD Handbook 4000.1 in March 2016. They were current and accurate as of this article’s date of publication, but they may have since changed. For the most current information available, refer to the HUD.gov website.
Initial Interest Rate Adjustments
The first interest rate adjustment on an FHA adjustable-rate mortgage must occur in accordance with the chart shown below. You can enlarge the chart for easier viewing.
For an FHA adjustable-rate mortgage, the Mortgagee / lender must underwrite the loan based on payments calculated using the initial interest rate. One-year ARMs have different guidelines, as shown below.
Underwriting a 1-year ARM
If the loan-to-value (LTV) of a 1-year ARM is 95% or higher, the Mortgagee / lender must underwrite the mortgage based on payments calculated using the initial interest rate plus one percent. If the loan’s LTV is less than 95%, the lender must underwrite based on payments calculated using the initial interest rate.
An FHA-insured ARM loan must fully amortize over a period of no more than 30 years.
Notes and disclaimers: The information above was adapted from HUD Handbook 4000.1, which is the official policy guide for the Federal Housing Administration loan program. We have made reasonable efforts to ensure the accuracy of this material. With that being said, the Department of Housing and Urban Development frequently makes changes to the program. For the most current guidelines and requirements regarding FHA adjustable-rate mortgages, please refer to the HUD.gov website or the handbook mentioned above. You can also contact the FHA Resource Center directly by calling 800-CALL-FHA (225-5342), or by sending an email to email@example.com.