FHA 5-year ARM vs. 30-Year Conventional Fixed Rate Loan

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  Which loan type is

right for you?             



FHA 5-Year ARM vs. 30-Year Conventional Fixed Rate Loan

Because people’s financing needs come in all shapes and sizes, there are a lot of loan products available.  And depending on the buyer and current interest rates, some loan types make more sense than others.

When intending to stay in their home for a long time, most people will consider a 30-year fixed-rate mortgage as the best option when interest rates are low.  But did you know that an FHA 5-year ARM loan may be an attractive financial choice in some cases?

Let’s start with the definitions for each of the loan types we’re talking about, discuss the advantages of an FHA 5-year ARM, and then get into a sample comparison:

Adjustable Rate Mortgage (ARM): The interest rate on an ARM is not fixed for the life of the loan. This mortgage adjusts periodically based on an index that changes with market conditions. The rate of interest is the sum of the index plus a margin. Most ARMs have periodic interest rate and payment caps, as well as a life cap.

5-Year ARM: The “5” in the 5-year ARM is the length of time that the interest rate is fixed. After that, during years 6-30, the rate is reset each year, and the monthly loan payment is recalculated.

FHA Loan:  FHA loans are mortgages that are insured by the Federal Housing Authority (FHA). The FHA has recently enhanced its loan program to better meet home buyer's needs with higher loan limits, competitive interest rates, and more flexible credit standards.

Conventional 30-Year Fixed-Rate Mortgage (FRM):  A mortgage in which the interest rate is fixed and does not change during the entire life of the loan.  A conventional mortgage is not insured or guaranteed by the federal government.

Why an FHA 5-Year ARM and why now?

  • Rates are at or near historical lows for FHA 5-year ARMs
  • FHA has low down payment requirements
  • Interest rate is fixed for the first five years and then cannot increase more than 1 percent per year thereafter
  • Interest rate cannot increase more than 5 percent above the initial rate, ever
  • Ideal for buyers who expect to relocate within the foreseeable future

Sample Comparison

FHA 5-Year ARM
Years 1-5 
Conventional 30-Year Fixed-Rate Mortgage
Years 1-30
Purchase price = $250,000 single family home Purchase price = $250,000 single family home
Minimum down payment 3.5% = $8,750 Minimum down payment 5% = $12,500
Mortgage amount includes financed MIP = $245,346 Mortgage amount = $237,500 
Interest rate1 = 3.875%  APR 3.379%
Monthly Principal and Interest Payment:   $1,153
Est. Monthly Mortgage Insurance:     $110
Est. Monthly Property Taxes:  $250
Est. Home Owners Insurance:  $100
                                   
Interest rate = 5.125%  APR  5.918%
Monthly Principal and Interest Payment: $1,293
Est. Monthly Private Mortgage Insurance: $187
Est. Monthly Property Taxes:   $250 
Est. Home Owners Insurance:  $100
Est. Monthly PITI:                                    $1,613 Est. Monthly  PITI:                                    $1,830         
Your loan’s interest rate will depend upon the specific characteristics of the loan transaction and your credit profile up to the time of closing. Minimum down payment requirements may be affected by credit history and/or property condition/location as determined by appraisal.  If the down payment is less than 20%, mortgage insurance may be required and could increase the monthly payment and APR.

Result
In this illustration, with a minimum down payment, the FHA 5-year ARM is $217 less per month, $2,604 less per year, and $13,020 less in the first five years!

Long-Term Scenario
We know that the FHA 5-year ARM can cost less over the first five years, but what about the period after the loan resets and interest rates change? 

Worst case scenario: using the above illustration, if the interest rate were to adjust the maximum amount of 1 percent each year for the first 5 years after the fixed period (capping out at 5% above the initial rate), the home buyer would still be better off the first nine years with the FHA 5-year ARM than with the conventional 30-year fixed-rate mortgage.

How long do you plan to live in your home? An FHA 5-year ARM may be an option worth considering!

For more information, contact Edina Realty Mortgage at 952-928-5300 or mortgage@edinarealty.com.

Contact an Edina Realty REALTOR® to start the home buying or selling process today!


This information deemed reliable, but not guaranteed.
1. Rate is subject to increase after consummation.


 

 


 

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