A Great Question From One of My Readers – “Is it a good idea to look at a FHA 5/1 ARM over a 30-yr Fixed? Right now, FHA 5/1 ARM interest rates are more than a full percentage point lower than a fixed rate. What do you think Dan?”
My reply this question is backed by real data from HUD/FHA and supports in detail why I support purchasing Seattle Real Estate with using a FHA 5/1 ARM.
Two Reasons Why A FHA 5/1 ARM Is A Good Option:
(1) Today, the gap between a FHA 30-yr fixed rate mortgage and a FHA 5/1 ARM is a tad bit over 1%, and that is profound.
(2) It’s important to note that the FHA 5/1 ARM is NOT the same ARM that gave our industry a bad name. It is my goal that by the end of this article that you will be educated by facts and be equipped with the right information to make a clear distinction between the FHA 5/1 ARM and the ARM that many Americans fear today.
Before I explain the benefits of the FHA 5/1 ARM, in the video below
I want to clarify the difference between a FHA 5/1 ARM and the “sub-prime” ARM. First, the ARM that buried America was a conventional ARM (5/2/10), not the FHA 5/1 ARM (1/1/5), a big difference between the two programs.
You see, the FHA 5/1 ARM has a max ceiling or “cap” of 5%, meaning the highest the interest rate could go up after year ten is 5% (5 years fixed plus an additional 5 years of the interest rate increasing at 1% each year – which over the past 50 years, mortgage rates have never increased 5 straight years in a row).
On the other side, the conventional ARM that harmed many Americans had a much higher initial ceiling or “cap” that caused people’s payment to sky-rocket by upward of 5% after year five, all at once… With a FHA 5/1 ARM, the maximum the interest rate could go up after year five is 1%, and over the last 30 years, the CMT index has not moved aggressive enough to cause a full jump in rate.
On a $200,000 loan amount, the difference between a 30-yr fixed and FHA ARM is about $130/mo. That is a savings of $7,800 over the 5 year ARM period. The other benefit of an ARM is that the lower interest rate allows for a greater pay-off of the loan amount. In this same situation, that is a saving of $3,183, a combined savings of $11,103 over 5 years.
So let me break this down for you. You purchase a FHA 5/1 ARM at 3.75% (for example). Now let’s plan for the worse. Worse case scenario, let’s say the rate goes up one full percent after year five. So, beginning year six, your rate increases to 4.75%… see below how your rate will continue to adjust on the anniversary date of the first adjustment until it caps at a max of 5 total percent of the original interest rate. Please note, this is worse case scenario, and we’ve yet to see worse case scenario index jumps in 30-years (see video).
For Example: This is a “worse case scenario” breakdown of a 3.75% FHA 5/1 ARM if the interest rate increased at a max rate of 1% each year after the 5th year.
Years 1 – 5: Rate: 3.75% = $926.23 (principle/interest pmnt)
Year 6: Rate: 4.75% = $1043.29 (principle/interest pmnt)
Year 7: Rate: 5.75% = $1167.15 (principle/interest pmnt)
Year 8: Rate: 6.75% = $1297.20 (principle/interest pmnt)
Year 9: Rate: 7.75% = $1432.82 (principle/interest pmnt)
Year 10: Rate: 8.75% = $1573.40 (principle/interest pmnt)
(the rates quoted above were from 2011, and rates have dropped – please contact Dan for an updated quote)
Although you have been able to see the short-term savings and financial strategy in using the FHA 5/1 ARM, it takes the right situation, the right person, and the right mortgage planner to help plan and guide the borrower through this strategy to ensure the savings are managed appropriately.
For more information to see if a FHA 5/1 ARM is the right loan program for you, contact Dan Keller for a FHA pre-mortgage planning and credit analysis. The best way to reach me to discuss the FHA 5/1 ARM or an FHA 203k rehab mortgage is to comment below or call me directly at (425) 350-7136.