FHA Adjustable Rate Mortgage - Pros and Cons of ARM Mortgage Loans

If you're a first time home buyer looking for an FHA adjustable rate mortgage, you should pay special attention to this information.

This page is kind of long. However, since your financial health is at stake here, I wanted to take the time (and cyber space) to clearly explain this subject to you. You need to take the time to read this over very carefully.

When you're looking for a home loan, you have a choice between the adjustable rate or ARM mortgage loans and the fixed rate mortgage loans. The following are the pros and the cons of the ARM mortgage.

Before I tell you about the adjustable rate mortgage, let me just say that I do not recommend them. In all the years that I was a loan officer I closed hundreds of FHA home loans and very few of them were the FHA adjustable rate mortgage. I would always encourage my clients to get a fixed rate mortgage.

Many times when looking at the fha arm loans, the client was trying to buy the most house with the lowest monthly payment. While it does help you do that, sooner or later you will pay the higher interest rate anyway. So I encourage you, my dear web visitor, buy less house and seriously consider the fixed rate mortgage over the arm mortgage loans.

The FHA adjustable rate mortgage is intended to be of service to homeowners in the event that interest rates are high. Or people will use them for the reasons as I mentioned above.

FHA adjustable rate mortgage is especially designed for families who have low to moderate incomes. Still, these families are attempting to become homeowners despite their income levels. So with that in mind, let's get down to business.

FHA ARM Loans Pros

The biggest pro of this loan product is that it allows low- and moderate-income people to keep their initial monthly costs down. You can buy a more expensive house because your monthly payments are lower. The closing costs on a arm loan is no different than on a fixed rate mortgage.

In addition, when the bond markets (this is the financial instrument mortgages are based on) start to fall, your payments on the loan also begin to decline in a corresponding fashion. Initially, in comparison with a fixed rate mortgage loan, an ARM loan will offer you a lower interest rate at the start.

FHA adjustable rate mortgage will adjust 1 time each year for 1, 3, 5, 7 or 10 years. The first adjustment comes only when the loan product allows it to. So if the market conditions are favorable, then your monthly payment will decrease.

You need to know how this mortgage product works. It has 4 parts to it.

1. Index (CMT Index or 1 yr LIBOR)
2. Margin (Bank profits)
3. Interest Rate (has a lifetime cap on how high it can go)
4. Initial Interest Rate (only for the first year in most cases)

So at first glance, the FHA adjustable rate mortgage seems like a good idea. You get more home for the money, a lower monthly payment and your payments could go lower with the financial markets when they are trending downward. However, currently rates are at historic lows. They have not been this low ever. So they have no where to go but up.

FHA ARM Loans Cons

Not everything is rosy with this type of loan. The most obvious con is that the opposite applies in situations when interest rates (based on the bond markets) begin to go up. Since they have no where to go but up, what does this mean? As they increase, so do the payments for this loan.

Remember I said there is an initial interest rate. This is a teaser rate in most cases and will be much lower than the fixed rate mortgage will be.

FHA offers at the time of this writing (DEC 2011) 5 different types of FHA ARM loans.

They have a 1 yr ARM, and a 3 Year Hybrid ARM that have annual caps of 1% and lifetime caps of 5%.

Also they have a 5, 7 and 10 year Hybrid ARMS that have annual caps of 2% and lifetime caps of 6%.

Another big disadvantage is the inherent instability in how this loan is designed. Your payments can change over time without any consistency. Basically, if you hold onto your ARM loan for long enough, your interest rate could even surpass what the going rate is for any fixed rate mortgage loans.

I cannot get into quoting interest rates because the ARM loans change daily. But for example purposes let's assume you have 1 year ARM at the rate say 3% to start with. After the first year, your rate would adjust to 4%. If you kept the mortgage for the entire 30 years, the highest that interest rate could go would be 8%. On a $100,000 mortgage, the increase in monthly payments would be around $56 more.

My Overall Conclusion

The fixed rate mortgage loan is recommended since it is really better for any first time home buyer. This is due to the fact that you as the borrower are well-guarded against any abrupt and likely sizable increases in your monthly mortgage payments when interest rates start going up. For this reason alone, a fixed rate mortgage loan provides better advantages than an FHA adjustable rate mortgage.

Now hopefully this is all as clear as mud for you. I know that in the long run, many of you will be better off using the fixed rate mortgage because you will know what your payments will be from year to year. There is no guessing or trying to time the markets.

While it's true you cannot buy as much house in the beginning, the only way your payments will increase is when taxes and insurance increase. At least this way you are not at the mercy of the greedy bad boys on Wall Street.

I have many more pages on FHA loans on this website. Feel free to browse around and get your questions answered.

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