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Are Adjustable Rate Mortgages (ARM) A Good Option?

For many families, owning a home symbolizes the American dream. Yet, with inflation and escalating interest rates, this dream can feel out of reach for borrowers struggling to secure mortgage financing. Luckily, the Federal Housing Administration (FHA) provides an adjustable-rate mortgage (ARM) – a loan with relaxed financial criteria and a low initial interest rate that spans a decade. 

Here’s a guide to help you grasp the FHA adjustable-rate mortgage and determine if it suits your needs.

Understanding FHA Adjustable-Rate Mortgages (ARMs)

The FHA offers a variety of mortgage loans with more lenient financial requirements. Typically, FHA loans do not demand as high a credit score or as favorable a debt-to-income ratio as conventional mortgages. These loans also usually call for a small down payment of 3.5%. Furthermore, FHA loans are backed by the federal government.

An FHA adjustable-rate mortgage comprises four key components: the initial interest rate period, index, margin, and interest rate cap. Initially, borrowers receive a low interest rate for a set number of years. Once this introductory period ends, the interest rate on the mortgage fluctuates based on a predetermined index, such as the Constant Maturity Treasury (CMT) and the U.S. Treasury for FHA loans. The margin indicates the increment by which the investor raises the mortgage’s interest rate using the index as a benchmark. Your interest rate is determined periodically by the index, margin, and the caps and floors specified in your mortgage agreement after the introductory period. Due to the margin, your interest rate will always be above the index.

The interest rate cap sets a maximum limit on your loan’s interest rate. For instance, an ARM with a 10-year introductory period might have a 1/1/5 limit structure. After the fixed-rate period, the interest rate cannot vary more than 1% from the initial rate. Although the interest rate may fluctuate annually afterward, it will not surpass 1% of the calculated rate. The last number in the structure signifies that the maximum total increase in the interest rate over the loan’s lifespan is 5%.

It’s crucial to understand that for most investors, the caps in your mortgage agreement function as both maximum and minimum interest rate limits. Just as the rate cannot exceed the specified amount, it also cannot drop below it, regardless of market interest rates.

In the example above, during the initial adjustment, the rate will not decrease by more than 1% or increase by more than 1% at each successive adjustment. Throughout the loan term, the rate will not decrease by more than 5%.

Is ARM Financing Available Through FHA?

Indeed, the FHA provides adjustable-rate mortgages (ARMs) with fixed-interest terms spanning 1, 3, 5, 7, and 10 years.

FHA Adjustable-Rate Mortgages

FHA provides various adjustable-rate mortgage options distinguished by the duration of the initial-rate period and the permissible interest rate range.

1-Year ARM

FHA adjustable-rate mortgages feature a 1-year introductory period, with the potential for an interest rate increase of 1% after the fixed-rate phase, and up to 5% over the course of the mortgage.

Hybrid ARMs

Hybrid ARMs derive their name from their extended initial rate periods. While the interest rates of these ARMs will eventually adjust, they typically provide a fixed interest rate for a significant duration. Consequently, they are categorized as hybrid loan products rather than solely adjustable-rate loans. Various forms of Hybrid ARMs include:

  • 3-year FHA ARMs feature an initial fixed interest rate for 3 years. Subsequently, the interest rate may increase by a maximum of 1% per interval, with a cap of 5% over the course of the mortgage.
  • 5-year FHA ARMs provide two options: a 1% annual increase up to 5% for the loan duration, or a 2% yearly increase capped at 6%. Both options fall under the category of a 5/1 ARM loan.
  • 7-year FHA ARMs: The interest rates on 7-year FHA Adjustable Rate Mortgages may increase by 2% yearly and up to 6% over the loan term.
  • 10-year FHA ARMs: The interest rates for 10-year FHA adjustable-rate mortgages can increase by 2% annually and up to 6% over the loan term.

Requirement For FHA ARMs

To qualify for an FHA ARM, home buyers need to meet specific mortgage requirements. Borrowers must be prepared for a mortgage lasting 15 to 30 years. While FHA ARM loans accept credit scores as low as 500, a 10% down payment is required at closing. Those with scores of 580+ need only put down 3.5%. Notably, Rocket Mortgage mandates a minimum credit score of 580 for FHA loans.

FHA may finance ARMs up to $970,800 based on your location. All FHA loans carry mortgage insurance premiums (MIP) to mitigate loan risks. MIP is paid monthly, along with a 1.75% upfront premium payable at closing or included in the loan.

Pros and Cons of FHA Adjustable-Rate Mortgages

While FHA ARMs present various benefits, it’s wise to consider some additional factors:


  • During the introductory period, borrowers are offered a rate that is lower than the fixed interest rates they could otherwise obtain.
  • Hybrid financial products offer borrowers an extended fixed-rate term for added flexibility.
  • Flexible criteria enable individuals facing financial challenges and credit hurdles to meet the qualifications.
  • A modest down payment is frequently required.
  • Caps and margins play a pivotal role in managing fluctuations in interest rates.


  • Adjustable interest rates have the potential to elevate your monthly payments to levels that may become unmanageable. Qualification is determined based on the maximum possible payment, which may not necessarily align with your evolving financial circumstances by the time the payment adjusts.
  • Mortgage insurance premiums inflate your monthly payments without contributing to the growth of your equity.

Is an FHA Adjustable-Rate Mortgage the Right Choice for You?

An FHA ARM can offer substantial benefits to homeowners planning a short stay or aiming to repay the loan during the fixed-rate phase. Those who capitalize on the low initial interest rate by reducing the loan balance before the adjustment can potentially save thousands with an FHA ARM. Moreover, individuals facing financial challenges may find FHA ARMs advantageous, allowing access to mortgages and homeownership. Another perk of an FHA ARM is the option to switch to a fixed-rate mortgage before the initial rate ends. This strategy enables buyers to start with an FHA ARM, then shift to a stable interest rate through refinancing, assuming fixed rates remain favorable and eligibility requirements are met.

Key Takeaway

FHA adjustable-rate mortgages (ARMs) provide numerous advantages for potential homeowners, especially those encountering financial hurdles. FHA ARMs broaden the pool of eligible borrowers, enabling individuals and families with modest incomes to achieve homeownership. Moreover, the favorable interest rates of FHA ARMs can extend up to a decade, affording borrowers sufficient time to refinance or settle the loan prior to any interest rate escalation.

If you’re considering an ARM for your home financing needs, kick off your application with Elevation Mortgage today. Feel free to reach out to us at 719.247.6622.

Picture of Reed Letson

Reed Letson

Reed offers two decades of expertise as a mortgage broker, focusing on veterans and first-time home buyers. With a strong grasp of real estate and mortgage markets, he empowers clients with practical insights. Reed's passion is guiding clients to build wealth through real estate investments and financing solutions.

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