What is an FHA ARM? A guide for borrowers.

Buying a house with an FHA loan already makes homeownership more accessible, thanks to its lower credit score and down payment requirements. But when you combine these government-backed loans with an adjustable-rate mortgage (ARM), you can make those first few years of homeownership even more affordable.

An FHA adjustable-rate mortgage combines two things: government-backed FHA financing and the features of an adjustable-rate loan. The Federal Housing Administration insures these loans in the same way it insures FHA fixed-rate mortgages, allowing lenders to extend more flexible credit standards and lower down payment requirements.

What sets an FHA ARM apart is its interest rate structure. With these loans, you’ll start with a fixed introductory rate, which is often lower than comparable FHA loan fixed rates. After that introductory term, your interest rate adjusts annually, rising or falling depending on an index — commonly the one-year Constant Maturity Treasury (CMT) or the one-year London Interbank Offered Rate (LIBOR).

FHA loan lenders also add a small margin to the interest rate, which ensures they make enough money to service your loan. Since the margin varies by lender, it’s key to shop around a bit to compare margins. Lenders must disclose their margin when you apply for a loan.

If an FHA ARM is starting to sound like an interesting mortgage option, you’ll be happy to know they come in multiple shapes and sizes.

• 1-year ARM. Adjusts annually after just one year of a fixed rate.

• 3-year ARM. Offers a three-year fixed period, followed by annual adjustments.

• 5-year ARM. Perhaps the most common FHA ARM term, offering a 5-year introductory term.

• 7-year ARM. Locks your rate for seven years before adjustment kicks in.

• 10-year ARM. Gives you a hefty 10-year introductory term before adjusting.

You may see these terms stylized as a 5/1 or 7/1 ARM in your mortgage documents. In these cases, the first number represents the intro-rate period, and the second number is the frequency at which the rate changes. So, a 5/1 ARM has a 5-year introductory period, and the rate changes every year.

Each product also comes with built-in borrower protections. FHA ARMs come with rate caps that limit how much your interest rate can increase or decrease after the first adjustment, each subsequent adjustment, and over the life of your loan. Note that 5-year FHA ARMs have two different options.

Let’s have a look at one of these loans in action so you can see how the adjustment period works.

Say you have a 5-year FHA ARM with an initial introductory rate of 5.25%. If you close today, you’ll enjoy that rate for the first five years or 60 months of payments.

Starting at month 61, your payment will change for the next 12 months based on current interest rates. If rates have increased, your interest rate will rise by a maximum of 1%. Your rate will continue to adjust annually, but thanks to the rate cap of 5%, the highest interest rate you could ever pay on this loan is 10.25%.

Before you start sweating, interest rates on FHA ARMs can also decrease, thereby lowering your monthly payment. The rate on the same 5-year ARM above could adjust downward up to 1% per year, with a lifetime decrease of up to 5%, giving you the potential for a mortgage interest rate of 0.21%.

While a rate that low is extremely unlikely, it shows that ARMs could be more favorable in a market where interest rates are expected to decrease in the future.

One of the biggest appeals of an FHA adjustable-rate mortgage is the lower starting rate. Because lenders price in less long-term risk, initial FHA ARM rates are usually lower than those of FHA fixed-rate mortgages. That difference can make monthly payments more manageable, especially for first-time home buyers balancing housing costs with other expenses.

For example, if the average 30-year fixed FHA loan is around 6.1%, you can expect an FHA ARM mortgage to have a lower mortgage rate during its introductory period.

However, a fixed-rate FHA loan locks in your rate for the entire term length (unless you refinance). This can make a fixed rate more affordable in the long run, especially if market rates increase.

An FHA ARM is most appealing for borrowers who expect to refinance their mortgage or sell their home before the adjustment period begins. If you get a 10-year ARM and plan to move within the first 10 years, you could benefit from the lower initial monthly payments without ever worrying about a rate adjustment.

Another reason you might like these loans is that a lower mortgage rate translates to a lower monthly mortgage payment. Recent graduates and those with higher future earning potential (like early career attorneys and physicians) can enjoy lower rates and payments while their careers get going and then move to a larger home once their earnings amp up.

On the other hand, those planning to stay in their home for the long term or concerned about fluctuating payments may prefer the predictability and stability of a fixed-rate FHA loan.

Dig deeper: The different types of FHA loans

• Lower initial monthly payments compared to fixed-rate FHA loans.

• Easier to qualify for than conventional ARMs, thanks to the FHA’s flexible credit score requirements for buying a house.

• Built-in rate caps that limit extreme payment shocks.

• Rising payments can take a bite out of your budget once the initial fixed period ends (if market rates increase).

• Potentially higher total loan costs over the life of your loan compared to a fixed-rate mortgage.

Read more: How to choose between an adjustable-rate vs. fixed-rate mortgage

If you’re considering an adjustable-rate mortgage backed by the FHA, a few strategies can help you make the most of these flexible loans.

• Understand the caps. Ask your mortgage lender to spell out the initial, periodic, and lifetime limits on your interest rate adjustments.

• Budget beyond the introductory rate. Make sure you can handle the highest potential payment if rates increase.

• Consider your timeline. If you expect to move or refinance in the next several years, choose an FHA ARM with an introductory rate term that aligns with your goals.

• Shop lenders. FHA ARM rates and margins can vary, so apply for mortgage preapproval to compare multiple quotes before locking down a lender.

Yes. The Federal Housing Administration (FHA) insures adjustable-rate mortgages in addition to its popular fixed-rate loans. An FHA ARM begins with a lower interest rate for a specified period — one, three, five, seven, or 10 years — before entering an adjustment period during which the rate can change annually. Like all FHA loans, FHA ARMs have flexible credit and down payment requirements. This makes them a potentially more accessible mortgage option compared to conventional mortgages, which require as much as 20% down at closing.

The Federal Housing Administration (FHA) has an adjustable-rate mortgage program, also called the Section 251 ARM program. Borrowers get FHA loans with variable interest rates, which stay the same for the introductory period and then fluctuate annually.

A 5/1 FHA ARM is a mortgage insured by the Federal Housing Administration, and the interest rate stays the same for the first five years. After that, your rate can change annually, based on market conditions. The appeal is that the starting rate is typically lower than that of a fixed FHA loan, allowing you to enjoy smaller monthly payments initially. That makes the 5/1 FHA ARM popular with buyers who expect to move or refinance before the rate starts adjusting.

Laura Grace Tarpley edited this article.