New HUD ARMs Program Opens Door to More Buyers

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“President Bush challenged us to work to close the minority homeownership gap. This will be an important tool to help create such opportunities for minorities and all Americans who are on the doorstep of homeownership,” said Acting HUD Secretary Alphonso Jackson in announcing the new program. John C. Weicher, Assistant Secretary for Housing/Federal Housing Commissioner, added, “For the first time ever, more than half of all minority households are now homeowners… and this initiative will continue the growth we have seen over the last three years and continue to close the minority homeownership gap.” It is important to remember that the government does not make home loans. Instead, it guarantees them, promising the lender that if the owner becomes delinquent in paying, the federal government will make up any loss.

Before looking at how the new ARM loans work, let’s look at why they are so important to low-income individuals trying to buy that first home. There are two major reasons that HUD-backed mortgages work well for low-income earners. The first is that it is easier to qualify for an FHA mortgage than for a conventional loan. Credit requirements are more flexible, and the agency also permits borrowers to carry more debt than a conventional lender might. The second reason is the amount of help available if a homeowner gets into financial trouble. HUD has more programs to help those who run into problems than most conventional lenders, and it is eager to find solutions other than foreclosure. Of course, the homeowner has to be willing to work with HUD, and he or she should call the agency at the first sign of financial trouble.

Now let’s look at the loans themselves. With a fixed-rate mortgage the interest rate is set when the loan is finalized and remains unchanged for the life of the loan. ARM loans start at one interest rate and adjust after a set period of time—often climbing higher. The time before that interest rate change happens is referred to as the length of an ARM. So, with a one-year ARM, the rate could change after one year. With a three-year ARM it could adjust after three years, and so on. Even though an ARM is a 30-year loan, you can’t be sure what the rate will be a few years down the road.

The initial interest rates for ARMs are lower than those for fixed-rate mortgages--the shorter the term of the ARM, the lower the rate. With good credit and the right numbers on your credit score, you could probably get a 30-year conventional loan for about 5.625 percent. A one-year ARM might be yours for 3.5 percent, a five-year for about 4.625 percent and a 10-year loan for about 5.25 percent. As you can see, the interest rate climbs along with the length of the ARM. Your risk, however, decreases. The longer the rate remains steady, the more sure you are of how much your home loan will cost for that period of time.

Once you reach the end of the fixed-rate period, the rate can adjust to meet prevailing rates. With a conventional ARM, you have to make sure that you have caps (limits on the amount of adjustment in the interest rate) and loan limits that protect you from too steep a rate hike. HUD has built those protections into its program. HUD has different caps and ceilings for ARMs of different lengths. For one, three- and five-year ARMs the interest rate cannot go up more than 1 percent per year and no more than 5 percent over the life of the loan. Let’s say you got your loan at 3.5 percent and at the end of the term mortgage rates climbed to 9.5 percent. The most your rate could rise would be 1 percent. At the end of the next year, if the rates were still 9.5 percent, your rate would go up another percent. It could keep increasing until it reached the ceiling--in this case a 5 percent increase to 8.5 percent even if the interest rate were to stay at 9.5 percent. For 7-year and 10-year ARMs the maximum increases are 2 percent annually with a 6 percent cap for the life of the loan.

Will ARM rates always climb? Not necessarily. In the past few years many people with ARMs actually saw their rates fall. Many individuals who choose ARMs do so because they know that they will be selling the home in a few years, often before the ARM adjusts. You might not know exactly when you’ll move again, but very few people in America today stay in one place for 30 years. Many first-time buyers, especially those starting a family, will move in a few years--most likely to a home with more space. It is important to realize that ARMs are risky. Interest rates can go up. Just because HUD now offers ARMs does not mean that you have to get one. All it means is you now have more options to study before you sign on the dotted line.