FHA adjustable-rate mortgage: What it is and how it works

For many families, homeownership is symbolic of the American dream. However, with inflation and rising interest rates, that dream may seem distant for borrowers having difficulties securing mortgage financing.

Fortunately, the Federal Housing Administration (FHA) offers an adjustable-rate mortgage (ARM), which can make getting a mortgage loan more affordable and lower the barriers to entry for homeownership. Before deciding whether an FHA ARM is right for you, consider how the mortgage process works, the different types of FHA ARMs, and the pros and the cons of FHA ARMs.

What is an FHA adjustable-rate mortgage (ARM)?

An FHA adjustable-rate mortgage loan comes with less strict financial requirements and a low introductory interest rate. An FHA ARM loan consists of four components: initial interest rate period, index, margin and interest rate cap.

• Initial interest rate period: Investors give borrowers an initially low interest rate on the mortgage for a fixed number of years.
• Index: Once the introductory period expires, the mortgage interest rate fluctuates based on an index preset in the loan conditions. For FHA loans, it’s typically the Constant Maturity Treasury (CMT) and the U.S. Treasury that determine mortgage rates.
• Margin: This refers to how much the investor increases your mortgage’s interest rate, using the index as a baseline.
• Interest rate cap: The interest rate cap sets an upper limit for your loan’s interest rate. For most investors, the caps in your mortgage contract also represent interest rate floors.

How do FHA ARM loans work?

Here’s an example to illustrate how FHA adjustable-rate mortgage loan rates work. Let’s say an ARM loan with an introductory, fixed-rate period of 10 years has a 1/1/5 limit structure. This means:

• Once the fixed-rate period ends, the interest rate can only rise or fall a maximum of 1% each year.
• The interest rate can never deviate more than 5% above or below the initial interest rate.

For another example, say you took out an adjustable-rate mortgage in 2024. That mortgage has a 10-year fixed-rate period at a 7% interest rate.

Your mortgage interest rate would stay the same until 2034. In 2035, it could go up to 8%, or down to 6%. The next year, it could adjust 1% up or down again.

However, it could never rise above a 12% interest rate, and never fall below a 2% interest rate.

Does the FHA offer ARM loans?

Yes, the FHA offers ARM loans with fixed-interest periods of 1, 3, 5, 7 and 10 years.

The FHA provides various mortgage loans with less stringent financial stipulations. Specifically, FHA loans usually don’t require as high of a credit score or as favorable of a debt-to-income (DTI) ratio as conventional mortgages. These loans also generally require a small down payment (3.5%). Additionally, the federal government insures FHA loans.

Types of FHA ARMs

The types of mortgages the FHA offers with adjustable rates come in variants based on the length of the initial-rate period and the allowed range of interest rates.

Standard 1-year ARM

FHA ARMs come with an introductory period of 1 year and can increase the interest rate by 1% following the fixed-rate period, and 5% throughout the mortgage.

Hybrid ARMs

Hybrid ARMs are named as such because they often include extended initial rate periods. Though the interest rates in these ARMs could eventually change, they typically offer a fixed interest rate for a considerable amount of time. As such, they are hybrid loan products rather than strictly adjustable-rate loans. Hybrid ARMs come in the following forms:

• 3-year FHA ARMs: 3-year FHA ARMs have an initial fixed interest rate lasting 3 years. Then, the interest rate can rise by 1% per interval and no more than 5% throughout the mortgage.
• 5-year FHA ARMs: 5-year FHA ARMs offer two alternative structures: a jump of 1% per year and 5% throughout the loan, or 2% per year and a maximum of 6% throughout the loan. Either is known as a 5/1 ARM loan.
• 7-year FHA ARMs: The interest rates of 7-year FHA ARMs can rise by 2% per year and 6% throughout the loan duration.
• 10-year FHA ARMs: The interest rates of 10-year FHA ARMs can rise by 2% per year and 6% throughout the loan duration.

FHA ARM requirements

FHA ARMs have specific mortgage requirements home buyers must meet to qualify for a loan. To obtain an FHA ARM loan, borrowers must:

• Be prepared to make payments on a mortgage that could last 30 years.
• Obtain a credit score of 500 or higher.
• Make a minimum 10% down payment at closing if their credit score is under 580.
• Make a minimum 3.5% down payment if their credit score is 580 or higher.
• Have a debt-to-income ratio of 43%.
• Provide proof of employment and steady income.

Depending on your region, the FHA can allow ARMs up to $1,209,750 in 2025. Additionally, all FHA loans charge mortgage insurance premiums (MIPs) to help offset the risks of the loan. You’ll pay an MIP as part of your monthly mortgage payment in addition to an upfront mortgage insurance premium of 1.75% that can be paid at closing or financed into the loan.

FHA adjustable-rate mortgage pros and cons

FHA ARMs offer numerous advantages, but it’s a good idea to be mindful of additional considerations:

Pros

• The introductory period typically gives borrowers a rate lower than comparable fixed-interest rate loans they might qualify for.
• Hybrid loan products help borrowers with a lengthy initial fixed-rate period.
• Flexible standards allow borrowers with financial difficulties and challenged credit histories to qualify.
• There’s often a lower down payment requirement than other loans.
• Caps and margins help control interest rate fluctuations.

Cons

• Adjustable interest rates can increase your monthly payment. When you qualify, it’s based on the highest your payment could ever be, but your financial situation might change before the payment adjusts.
• Mortgage insurance premiums raise your monthly payment without helping you build equity.

Is an FHA ARM right for you?

An FHA ARM can provide significant benefits if you plan to own your home for just a few years before selling or can pay off the loan during the fixed-rate period. Borrowers who can take advantage of the low initial interest rate – by paying down their loan before the rate adjusts – have the opportunity to save thousands of dollars through an FHA ARM.

Additionally, borrowers with less-than-ideal financial circumstances may find FHA ARMs helpful. The standards allow borrowers who may have trouble accessing other mortgage loan products to get a mortgage and become homeowners.

Another advantage an FHA ARM presents is the opportunity to refinance the loan to a fixed-rate mortgage before the initial rate expires. This way, borrowers looking to save money could purchase a home with an FHA ARM, and then refinance to a mortgage with a permanent interest rate. Of course, this assumes fixed rates haven’t increased substantially and that you qualify to refinance.

The bottom line

FHA ARMs are mortgage loan products offering an array of benefits to many prospective homeowners, particularly those who face financial challenges. A wider range of borrowers qualify for FHA ARMs, allowing individuals and families with less income to become homeowners.

Additionally, the low interest rate of an FHA ARM can last for up to 10 years, giving borrowers ample time to refinance or pay off the loan before the interest rate jumps.

If you’re interested in an FHA loan to finance your home, start the mortgage approval process with Rocket Mortgage® today.