FHA Loans In 1934 the government set up the Federal Housing Authority (FHA) to help stimulate an economy in crisis. FHA programs were designed to help people buy their houses rather than rent. FHA programs allow more flexibility than is available for borrowers seeking conventional loans (Fannie Mae criteria). However, the FHA does not actually make the loans; they insure them. Working with approved lenders, the FHA serves to lower the risk for the lender, thus making loans more readily available. If the borrower defaults, FHA pays the lender. Even though the insurance cost is passed down to the home owner, after paying down the loan, the borrower may drop the insurance. The equity that has been built up serves as the security the lender needs to feel comfortable with the loan. With an FHA loan, if the borrower experiences unforeseen hardships, FHA has options to help keep the home out of foreclosure. The lender must follow FHA's servicing guidelines; therefore, an FHA insured loan offers the borrower protection as well as the lender. FHA programs do have some loan requirements, but they are not as strict as conventional loans. They generally require less down, less stringent credit, and the ability to finance a higher percentage of the value of the house. For instance, FHA only requires a minimum 3% down payment—which is low by industry standards. Also, while they do look at credit history, they are more flexible than conventional loans, looking more at the borrower's ability to repay than at any problems in the past. Although the requirements are less strict than conventional loans, by law, the FHA can only insure loans up to a maximum amount depending on where the home is. The FHA Maximum Mortgage Limits site will let you look up the limits for the areas of choice. Likewise, the loan size is restricted to a maximum amount of the value of the home. However, it is a very high amount (often up to 97% of the value). So the regulations governing FHA loans are very liberal. In the long run, FHA loans are much like any other except that they are generally easier to qualify for, and the borrower has more insurance against foreclosure. FHA programs also offer more than just home purchasing plans. They offer refinancing in order to lower interest rates or payment amounts; they offer remodeling money; they even offer cash out or debt consolidation loans.  Whatever your needs are, FHA may be a valid option to pursue.   Adjustable Rate Mortgage The structure of an Adjustable Rate Mortgage (ARM) is more complex than a Fixed Rate Mortgage (FRM).  In general, the ARM has periodic times when the interest rate and payment are adjusted.  Usually, ARMs offer lower initial interest rates than a FRM, but there is a risk of higher payments in the future when the index (see below) changes. ARMs have an adjusting time period built into the loan such as one month, one quarter, one year, three years, or five years.  A 1-year ARM would adjust every year, whereas a 3-year ARM would adjust every three years.  When the loan is adjusted at each adjusting period, the loan payment will likely change—often for the worse.  However, there are some limits built into the system to help protect the borrower (see caps below).  Besides the adjustable characteristic of an ARM, the interest itself is more complex.  There are two levels of determining factors that affect how the ARM interest is adjusted.  First, the ARM is tied to an index which measures interest fluctuations over time.  Second, there is an interest margin that the lender adds on to the index amount.  This margin generally stays constant through the life of the loan, but the index changes according to the particular index used.  Make sure you know both which index is being used and what the interest margin is when you choose an ARM.  Find out how stable the index has been over the past years.  You may have to find an ARM with a more secure history. The specific index will determine: the interest rate adjustment the maximum size of interest adjustment that can be made each adjusting period the maximum interest rate that can be given for that loan and any caps on payment amount The cap placed on the size of the interest rate adjustment will determine how quickly your loan will jump to the maximum amount.  While these caps offer some security, there are some pitfalls!  Sometimes, the adjustment happens too quickly, causing the payments to rise dramatically.  Also, caps placed on the payment amount may result in a payment that won't cover the interest.  The deferred interest adds to your loan.  You pay more interest as a result.  Your loan is now into a negative amortization.  You might think you are paying down your loan, but instead, your loan is actually growing. Payments can also jump higher when an initial discount rate expires (especially if it is at the same time that a scheduled adjustment happens).  Sellers or home builders will pay these buydown fees as an incentive or to help get terms that work for a buyer.  Once again, there are pitfalls!  Often the price of the house is raised by the amount of the fee, which in the long run, may negate the initial benefits. Also, the payment may jump so high that the home owner simply can't make the payment.  There are other features that can be incorporated creating a variety of types of ARMs such as interest-only ARMs, payment-option ARMs, or a hybrid loan. Because of the complexity of adjustable rate mortgages, the buyer must be very careful in choosing the right ARM.  Don't be afraid to ask your lender specific questions.