FHA home loans come with either a fixed or adjustable interest rate. They make homeownership more accessible to many borrowers, and while an adjustable-rate mortgage (ARM) typically has a lower introductory rate, it isn’t without risk. Here are the basics of FHA ARM loans.

Adjustable-rate mortgages overview

An adjustable-rate mortgage, or ARM, is a type of home loan with an interest rate that changes over time. ARMs have a lower, fixed rate at the start of the repayment period, usually three, five or seven years. Afterward, the rate can move up or down at predetermined intervals, such as every six months or one year, up to a certain limit. This means your monthly mortgage payment could increase or decrease over the remaining loan term. If the payment goes up, it might no longer be affordable with your budget. For this reason, lenders typically qualify ARM borrowers based on their ability to repay a higher payment.

FHA loans overview

FHA loans are insured by the Federal Housing Administration (FHA) and offered by FHA-approved mortgage lenders, which include banks and online lenders. They’re geared toward lower-credit score borrowers, including first-time homebuyers, who do not qualify for a conventional loan. FHA loans only require 3.5 percent of the home’s price as a down payment, but also require the borrower to pay mortgage insurance premiums, and impose a limit on how much can be borrowed. These are some of the disadvantages to this type of loan.

How do FHA ARM loans work?

An FHA ARM loan works similar to other adjustable-rate mortgages in that the interest rate remains the same for a period of time, then changes at preset times until the borrower fully repays the loan.

These changes are based on an index — for FHA loans, either the Constant Maturity Treasury (CMT) index or the Secured Overnight Financing Rate (SOFR) — and a margin of the lender’s choosing. After the initial fixed period, the lender adds their margin to the index to come up with new rates. Depending on current economic conditions, the adjusted rate might be higher or lower.

Your rate can’t increase or decrease beyond a specific amount, however. On ARM loans, there are both lifetime and annual caps — upper and lower limits on rate changes on a yearly basis as well as for the duration of the loan’s term.

Types of FHA ARM loans

There are five kinds of FHA ARM loans:

  • 1-year FHA ARM: Your interest rate stays the same for the first year of the loan’s term. After that, the rate can only increase by one percentage point (for example, 5.5 percent to 6.5 percent) per year and five percentage points for the life of the loan.
  • 3-year FHA ARM: Your interest rate stays the same for the first three years, but the caps are the same as the 1-year ARM.
  • 5-year FHA ARM: Your interest rate stays the same for the first five years. After that, the rate can only increase annually by one percentage point, and by five percentage points over the life of the loan; or by two percentage points annually and six percentage points over the life of the loan.
  • 7-year FHA ARM: Your interest rate stays the same for the first seven years, then can adjust by up to two percentage points per year and six percentage points over the life of the loan.
  • 10-year FHA ARM: Your interest rate stays the same for the first 10 years, but the caps are the same as the 7-year ARM.

FHA ARM loan requirements

Acceptable properties Primary residences
Borrowing limit $420,680 for a one-unit property, or $970,800 for a one-unit property in high-priced housing markets
Credit score At least 580, or as low as 500 with a bigger down payment
Debt-to-income (DTI) ratio 43%, or up to 50% in certain circumstances
Down payment 3.5%, or 10% with a 500-579 credit score
Employment Proof of employment from the past two years
Income Latest pay stub along with proof of any bonuses, commissions, etc., if consistent
Mortgage insurance premiums (MIP) 1.75% of amount borrowed, plus annual premiums based on amount borrowed, down payment and loan term (15 or 30 years)

If your credit history is lacking, FHA now allows lenders to include rental payments in their assessment, as well. As the borrower, you need to be able to show proof you’ve paid your rent on time every month for the past year.

FHA ARM loan rates

ARMs tend to have lower introductory rates compared to fixed-rate loans. As of mid-October 2022, ARM rates on Bankrate averaged just slightly lower than those of fixed-rate loans. FHA loan rates overall, however, averaged somewhat higher than conventional rates.

When comparing FHA ARM offers, consider the introductory rate along with the lender’s margin. Generally speaking, the lower the margin, the better.

With rates rising, consider the type of FHA ARM, as well. The one-year and three-year ARMs, for example, have lower caps, meaning you won’t see as big of a jump in your rate if prevailing rates do go up in the future.

Refinancing an FHA ARM

Many borrowers refinance before the first ARM rate reset. You might want to refinance out of an ARM loan if rates have dropped since you first obtained the loan and you want the stability of a fixed rate. You can also refinance to another ARM.

If you qualify, you might want to refinance from an FHA mortgage to a conventional loan, too. This allows you to eliminate (or work toward eliminating) mortgage insurance premiums, as conventional loans only require insurance if you have less than 20 percent equity in your home. In contrast, most FHA loans require you to pay insurance for the entire loan term, regardless of how much you’ve paid down on the mortgage.

Keep in mind, refinancing is typically only worthwhile if you can get a lower rate and pay the closing costs. If you won’t be in the home long enough to recoup those costs and realize the savings, it might not make financial sense to refinance.

Should you get an FHA ARM loan?

Pros

  • Attractive introductory interest rates
  • Easier to qualify for if your credit needs work
  • Gets you into a home sooner thanks to a lower down payment requirement and more affordable monthly payment upfront

Cons

  • Risk of future increases to rate, which can make monthly payments unaffordable, potentially forcing you to sell the home and move or increasing your risk for foreclosure
  • Need to refinance to remove mortgage insurance premiums
  • Limited to buying a home with a mortgage within loan limits and for use as primary residence