Why an FHA Adjustable-Rate Mortgage Makes Sense Now

FHA loans are a great option for homebuyers who can’t qualify for conventional mortgage loans due to poor credit or low down payment funds. Backed by the Federal Housing Administration (FHA), these home loans offer options: You can choose a fixed-rate or an adjustable-rate mortgage (ARM).

FHA ARM loans come with a few additional perks, including low interest rates and monthly payments for the first few years of the mortgage. The low cost of an FHA ARM loan can provide relief from high interest rates during the loan’s initial phase. However, the risk with an ARM loan is that once the interest rate begins to “adjust,” your payments could increase. Here’s what you need to know to determine whether an ARM makes sense for you in today’s market.

What is an FHA ARM loan?

FHA ARM loans have two phases: an initial period during which the interest rate is fixed and a later period during which the interest rate adjusts (or changes).

You can tell how long the initial period lasts from the name of the loan. A 5/1 ARM, for instance, has an initial period of five years, after which the rate will adjust once per year. There are also one-year, 3/1, 7/1 and 10/1 FHA ARM loan options.

For all ARM loans, it’s important to understand that when the interest rate changes, your monthly mortgage payment will also change.

The appeal of an ARM loan is:

  Interest savings: During the initial fixed-rate period, you’ll likely pay a lower interest rate than on a 30-year fixed-rate loan. This can save you money if you plan to sell or refinance the home before the ARM begins adjusting. Even if you don’t sell or refinance, you could still save money if the market trends downward during your loan term.

  Lower monthly payments: The lower interest rates of ARM loans result in lower monthly payments, which can help first-time homebuyers — or anyone feeling pressured by a tight market — buy a home without stretching their budget too thin.

  Qualifying for a bigger loan: For many borrowers, an ARM means they can afford a more expensive home than they could with a fixed-rate loan. As a result of the initial low rate and low monthly payment, borrowers may be able to purchase “more house” with an ARM.

What you need to know:

 Because an ARM’s rate could increase once the initial fixed period is over, keeping up with higher monthly payments may become more difficult over time.

 It’s important to look at the rate caps that come with an ARM. These caps limit how much the interest rate can increase both annually and over the life of the loan. This protection can make ARMs less risky than they might seem at first glance, providing a measure of security against dramatic increases in your mortgage payments.

Jump down to our list of ARM types below to see what rate caps they come with.

Are ARM loans bad?

Many people associate ARMs with the subprime mortgages that helped trigger the 2008 financial crisis. However, today’s ARMs and nonprime mortgages are not the same as the subprime mortgages that played a role in the Great Recession. In fact, today’s ARMs can be less risky than fixed-rate mortgages, and the average ARM borrower tends to be more creditworthy than the subprime borrowers targeted by predatory lenders in the early 2000s.

5 reasons why an FHA ARM loan makes sense today

Choosing an FHA ARM doesn’t make sense for everyone, but under specific financial circumstances and market conditions, it can be a savvy move. Here’s why opting for an FHA ARM might make a lot of sense right now:

1. Interest rates and home prices are high.

FHA ARMs usually offer lower initial interest rates compared to fixed-rate mortgages. This lower rate can be particularly appealing during periods of relatively high interest rates, as it can significantly reduce your initial monthly mortgage payments.

2. Short-term ownership is common.

If you plan to own your home for less than a decade, an FHA ARM might make more sense than a fixed-rate mortgage. Since the initial interest rate is lower, you can save on interest payments during the time you live in the house without worrying about future rate adjustments. These days, the average American homeowner sells their home within 12 years, according to Consumer Affairs.

3. Wages are rising.

Americans’ wages are the highest they’ve ever been, and unemployment is quite low. If you expect your income to increase in the future, the initial lower payments of an FHA ARM can provide financial flexibility. By the time the rate adjusts, your higher income may be able to comfortably cover any potential increase in payments.

4. Current market conditions make a difference.

In a rising rate environment, starting with a lower interest rate can be advantageous for homebuyers, especially if you believe rates will stabilize or decrease in the future. An FHA ARM provides the opportunity to benefit from a lower rate initially while offering the potential for rate decreases in future adjustments, depending on market trends.

5. The “great wealth transfer” is coming.

Experts predict that baby boomers will leave $72 trillion to their heirs over the next two decades. If you’re a member of Generation X, Millennials or Gen Z, it could be beneficial to consider how the inheritance you stand to receive (if any) could affect the risk you would take on with an FHA ARM loan.

6. FHA’s streamline refinance option is available.

FHA offers a “streamline” refinance option for existing FHA mortgages, including ARMs. If interest rates fall or your financial situation changes, you might be able to refinance to a lower rate or different mortgage type — without having to worry about any changes in your income or credit. That’s because an FHA streamline refinance doesn’t require you to verify earnings or employment.

Monthly payment and total cost comparison: 30-year fixed vs. 5/1 ARM

Below we compare a fixed-rate loan for $350,000 to an ARM loan for the same amount. Both loans are fully amortizing over 30 years, and the ARM’s rate is fixed for 60 months and then adjusts by 1% at its first adjustment. After that, it adjusts by 0.50% every 12 months, up to a maximum of 5% over the initial rate. The initial interest rates given are examples based on the average rates for these loan types on the LendingTree platform in 2024.

Monthly payment takeaway: If you chose an FHA 5/1 ARM you’d save $12 per month or $144 per year — $720 total — in the first five years. However, once the interest rate begins to adjust you’d see payments up to $1,102 more expensive per month than the FHA fixed-rate loan. 

Total cost takeaway: If you stayed in the ARM loan for the full 30-year term, you’d end up paying $282,941 more in total interest. Many ARM borrowers plan to exit the loan before the rate begins adjusting to avoid the years of elevated interest costs. 

Types of FHA ARM loans

All FHA ARMs offer a fixed interest rate for the initial period, which can last one, three, five, seven or 10 years. After this introductory phase, the interest rate adjusts on a yearly basis, within limits set by the loan’s rate cap structure.

The Consumer Financial Protection Bureau (CFPB) recommends avoiding any ARM loans if you can’t afford the highest possible monthly payments. Don’t assume the loan won’t adjust to the maximum interest rate. If you need help calculating what an ARM loan’s highest payment can be, use an online ARM calculator.

FHA ARM loan requirements

 500 credit score minimum

Although credit score requirements vary by lender, the FHA guarantees loans for borrowers with a credit score as low as 500, so long as you have a down payment of at least 10%. Check your credit score and make sure all the information on your credit report is correct.

 3.5% down payment minimum

All FHA loans offer a relatively low down payment requirement. But keep in mind that if your credit score is weak, you’ll have to compensate with a bigger down payment. Borrowers with a credit score of 580 or higher can put as little as 3.5% down, while those with a credit score between 500 and 579 will have to put 10% down.

 43% DTI ratio maximum

Lenders will look at your debt-to-income (DTI) ratio to assess whether you can afford to pay your mortgage. They calculate your DTI by adding up your monthly debt payments and dividing that total by your gross monthly income. The maximum DTI ratio for a FHA loan is slightly lower than the 45% maximum for conventional loans.

 Cash reserves

If your credit is below 580 or your DTI is above 43%, you may be required to show that you have a certain amount of cash on hand to cover any house-related expenses that might come up.

 Mortgage insurance

FHA loans require two types of mortgage insurance: a one-time, upfront mortgage insurance premium (UFMIP) and an ongoing annual mortgage insurance premium (MIP). If your down payment is less than 10%, you’ll pay MIP for the entire loan term, but if you put at least 10% down, you’ll stop paying MIP after 11 years.

 Property type

An FHA loan can only be used to finance a primary residence, meaning you must live there for at least 12 months.

Pros and cons of an FHA ARM loan

Pros

 Low rates: The low initial interest rates offered by ARMs can help you afford a more expensive home than you might qualify for with a higher rate. This lower rate could also mean a lower monthly payment, allowing you to save money or put your resources toward other financial goals.

 An affordable down payment: You may qualify with a down payment as low as 3.5% if you have a credit score of at least 580.

 Flexible credit requirements: Individual lenders set their own requirements for minimum credit scores, but the FHA guarantees loans with a minimum credit score of 500.

 Protection from excessive rate increases: While the interest rate will increase after the initial fixed-rate period, it can’t rise by more than 1 to 2 percentage points each year. It also can’t increase by more than 5 to 6 percentage points over the life of the loan.

Cons

 High monthly payments: Because the rate fluctuates after the fixed-rate period ends, it could go up. If it does, your monthly payment could also rise — potentially to a point where it becomes unaffordable.

 Mortgage insurance: When you receive an FHA ARM loan, you have to pay an upfront mortgage insurance fee of 1.75% of the loan amount in a lump sum to insure the loan. Additionally, you have to pay an annual mortgage insurance premium, which ranges from 0.15% to 0.75% of the loan amount, throughout the loan term.

 Loan limits: FHA ARM loan limits are typically lower than the conforming loan limits that govern conventional mortgages, which means they could be too low to cover the cost of a home in your area.

Is an FHA ARM loan a good idea for me?

An FHA ARM loan can be a good choice if:

You don’t plan to own your home for long

If you know you’ll be moving soon, you could take advantage of the FHA ARM loan’s initial low rate. If you sell your home before the rate begins to adjust, you could come out with significant savings versus financing with a 30-year fixed-rate mortgage.

You can pay for the loan even if the rate increases

It’s important to understand just how much your FHA ARM loan could cost over its full term. Ask your lender what the maximum monthly loan payment could be. If you can afford it, an FHA ARM loan could be right for you.

You want to pay off your mortgage early

Because you’ll have a fixed lower rate at the beginning of your FHA ARM loan term, you could make extra payments in order to pay down the principal faster. That would not only help you pay off your mortgage sooner but could also save you thousands of dollars in interest.

You want to buy a home while rebuilding your credit

Since you can qualify for an FHA ARM loan with a lower credit score than conventional loan requirements require, you could buy a house now instead of waiting until you rebuild your credit.

You’re expecting a pay raise or windfall

If you expect a raise or windfall in the near future, getting an FHA ARM loan could be a good fit because you’ll be able to afford the monthly payments now and later, even if the interest rate increases. Just make sure that your income increase is a certainty, not just a hope — if it doesn’t come, could you still afford your mortgage? If the answer is no, you could risk losing your home to foreclosure.

You can refinance into a conventional loan

Refinancing an ARM into a fixed-rate conventional loan is likely your best option if you’re looking to avoid the risk of your ARM adjusting to an unaffordably high interest rate.

Refinancing into a conventional loan can also help you eliminate FHA mortgage insurance. You may still have to pay mortgage insurance at first — assuming you don’t yet have 20% equity in the home — but you won’t be locked into it for the life of the loan. Once you reach 20% equity, you can get rid of that pesky mortgage insurance line item on your monthly payments.