Special Rules Provide Protection for Borrowers
Adjustable Rate Mortgages (ARM) can give borrowers who qualify a lower introductory rate than they would otherwise qualify for during the loan’s initial period. The time frame is generally a year or more. Many people are unaware that the FHA offers such loans. FHA ARM loans give borrowers initially low rates for a year or longer. Interest rates are adjusted thereafter according to a specified scheduled over the life of the loan.
FHA ARM loans include introductory rates that are fixed initially for as little as 1 year or as much as 10 years. After this introductory period has elapsed, the loan can be adjusted between 1 and 2 interest points. These loans will also have an “interest rate cap” that will exist throughout the life of the loan. Depending on the loan, the cap will limit interest rate changes to 6 points.
According to FHA terms, the borrower and lender negotiate what the initial; interest rate and margin will be. The margin has to be constant throughout the term of the loan. The interest rate remains constant for the initial period which may be for 1, 3, 5, or 10 years. Rates than can change on an annual basis.
Lenders Must Follow Special Provisions
Lenders must provide borrowers of FHA ARM loans with a written explanation of the nature of the loan. The disclosure requirements have to be consistent with the tenants covering a principal dwelling under the Truth in Lending Act., Regulation Z of the United States Code 1601, and the Code of Federal Regulations 226.18.
The FHA further requires the lender to “provide the borrower with a hypothetical monthly payment schedule that displays the maximum potential increases in monthly payments for the term of the ARM. The hypothetical payment schedule should illustrate the maximum increases over the shortest possible time frame.”
The FHA gives an example of how this would work. In it, a 7 year ARM payment schedule shows the largest possible increases over 3 years that follow the initial fixed rate period of 7 years.
These rules are designed to provide transparency. They allow borrowers to understand exactly how their loan will work so they can plan ahead for any increases that may occur. Lenders have to provide borrowers with the following information:
- –The initial interest rate
- – The ARM loan margin
- – The date of the first adjustment to the interest rate, and
- – The frequency of adjustments.
Initial Low Rates Are the Attraction
For borrowers who qualify, FHA ARM loans can provide a lower introductory rate than they would otherwise be eligible for. The borrower will enjoy this lower rate for at least a year, and these terms may last as long as 10 years. Many borrowers factor inflation into their calculation both in relative terms of what their payments will be and what their future earnings will be. The thinking is that payments will be more affordable over time and that earnings will likewise grow in the future.
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