3 1 ARM: Your Guide to 3-Year Adjustable-Rate Mortgages

January 6, 2025 9:44 pm Published by wp-admin Leave your thoughts

Let’s say you’re looking to buy a home worth $200,000 with a 20% down payment. Your lender offers you a 3/1 ARM with an initial rate of 3% and a cap structure of 2/2/5. But when fixed interest rates are at all-time lows, there’s not much of an advantage to choosing an adjustable rate.

What Is a 3-Year Adjustable Rate Mortgage (ARM)?

3-year ARM interest rates are based on the SOFR (Secured Overnight Financing Rate), so they change every day. For today, Monday, January 06, 2025, the national average 5/1 ARM interest rate is 6.53%, flat compared to last week’s of 6.53%. The national average 5/1 ARM refinance interest rate is 6.41%, down compared to last week’s of 6.42%. Knowing what type of mortgage you’re getting can be a challenge, since so many things that sound like a good idea are often the things that can cost you the most money.

• For this example, we assume you’ll take out a 5/1 ARM with 2/2/6 caps and a margin of 2%, and it’s tied to the Secured Overnight Financing Rate (SOFR) index, with an 5% initial rate.
• They come in handy, especially when rates rise rapidly — as they have the past year.
• With this type of mortgage, the actual indexed rate is fixed for the first three years of the loan, and then adjusts every year thereafter, a sort of hybrid between a fixed rate and an adjustable rate.
• But if you’re unsure how long you plan to stay in the home, a 7/1 or 10/1 ARM might be a safer choice.
• It’s important to know whether the loans you are considering have a higher initial adjustment cap.
• The easiest way to shop for an ARM loan is to choose one with a start rate period that comes close to the time in which you expect to own the home or have the loan.

Is an adjustable-rate mortgage right for you?

Yes, you always have the option to refinance an ARM into a fixed-rate loan — as long as you can qualify based on your credit, income and debt. You can use the savings to pay off your mortgage faster and build home equity. Alternatively, you can use the funds for other financial goals, like saving for college or retirement.

What are today’s mortgage rates?

If you’re buying your forever home, think carefully about whether an ARM is right for you. But at the conclusion of the initial fixed-rate period, ARM rates begin to adjust until the loan is refinanced or paid in full. These rate adjustments follow a set schedule, with most ARM rates adjusting once per year.

What is a 3/1 ARM?

It’s important to know how the loan is structured, and how it’s amortized during the initial 3-year period & beyond. Adjustable-rate mortgages (ARMs) can come with starting rates that are lower than comparable 30-year fixed mortgage rates. When mortgage rates rise, borrowers are often drawn to the temporary payment savings offered by initial ARM rates. Buyers like 3-year ARMs because the initial fixed rate is often lower than rates for other kinds of mortgages. But once the adjustable rate kicks in, you can expect higher monthly payments (though within certain limits). An adjustable-rate mortgage is a type of mortgage loan with an interest rate that adjusts or changes, up and down, as it follows wider financial market conditions.

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On the other hand, if you have a lot of cash on-hand, you can make a big down payment and buy mortgage points. If your interest rate is set at 3.5%, then your monthly P&I payment will remain at $718 until you pay off the loan or refinance. Always read the adjustable-rate loan disclosures that come with the ARM program you’re offered to make sure you understand how much and how often your rate could adjust. There are several moving parts to an adjustable-rate mortgage, which make calculating what your ARM rate will be down the road a little tricky.

How does a 3/1 ARM loan work?

• If you still have the ARM loan when the adjustment period begins, your rate could increase.
• That way you can make sure you’re getting the best deal on your home loan.
• To make sure you can repay the loan, some ARM programs require that you qualify at the maximum possible interest rate based on the terms of your ARM loan.
• This is generally the safer type of 3-year ARM for most people, since there is no potential for negative amortization.
• To make it a little easier, we’ve laid out an example that explains what each number means and how it could affect your rate, assuming you’re offered a 5/1 ARM with 2/2/5 caps at a 5% initial rate.
• These rate adjustments follow a set schedule, with most ARM rates adjusting once per year.
• But if the rate increases, your monthly mortgage payments will also rise.

The ARM’s rate can then rise, fall or stay the same, depending on the movements of the broader market. A 3-year adjustable-rate mortgage functions a lot like any other ARM. The main differentiator with these loans is the length of the introductory period, during which the interest rate stays fixed.

How ARM rates work: 3/1, 5/1, 7/1 and 10/1 mortgages

Though 3-year loans are all lumped together under the term “three year loan” or “3/1 ARM” there are, in truth, more than one type of loan under this heading. Understanding which of these types are available could save your wallet some grief in the future. Some types of 3-year mortgages have the potential for negative amortization. This table does not include all companies or all available products. The 7-year ARM rate can increase by up to 5% at the first adjustment and up to 1% at subsequent adjustments.

Compare current 3-year ARM rates by loan type

An adjustable-rate mortgage, or ARM, is a home loan that has an initial, low fixed-rate period of several years. After that, for the remainder of the loan term, the interest rate resets at regular intervals. The caps on your adjustable-rate mortgage are the first line of defense against massive increases in your monthly payment during the adjustment period. They come in handy, especially when rates rise rapidly — as they have the past year. The graphic below shows how rate caps would prevent your rate from doubling if your 3.5% start rate was ready to adjust in June 2023 on a $350,000 loan amount. With this type of mortgage, the actual indexed rate is fixed for the first three years of the loan, and then adjusts every year thereafter, a sort of hybrid between a fixed rate and an adjustable rate.

1 vs 7/1 ARM rates

• One of the most common rate cap structures is the 2/2/5 cap structure.
• ARM start rates are frequently lower than those of a fixed-rate loan.
• If you’re buying a house, keep in mind that you might have to pay a real estate title transfer tax in addition to property taxes.
• At each rate adjustment, the lender will add your margin to your index rate to get your new mortgage rate.
• There are several moving parts to an adjustable-rate mortgage, which make calculating what your ARM rate will be down the road a little tricky.
• A 3/1 ARM can be a good idea if you plan to refinance your home before the fixed period expires.
• Especially if you expect interest rates to drop in the next three years, you may want to refinance with a conventional fixed-rate loan.

With a 3-year adjustable-rate mortgage, you could get in over your head if your rate adjusts too high. Hybrid mortgages, like a 3/1 ARM, provide a variety of benefits, but come also with downsides. The advantage is that borrowers initially have access to mortgage rates that are usually lower than the ones available to people interested in 15-year or 30-year fixed-rate mortgages. However, 3/1 ARMs can be considered risky home loans because homeowners don’t know exactly how their interest rate will change after the initial fixed-rate period ends. When you get a mortgage, you can choose a fixed interest rate or one that changes.

• I’ve been writing and editing stories in the personal finance sphere for two decades, for publications like Business Week and Investopedia, covering everything from entrepreneurs to taxes.
• A one-time windfall, like an inheritance, can also let you pay off your mortgage before the higher monthly payments start.
• Generally speaking, a shorter fixed-rate period will get you a lower starting interest rate.
• If you plan to move and sell your home before your adjustable rate kicks in, a 3-year ARM can save you money with low monthly payments.
• Interest rate caps save many homeowners with 3/1 ARMs from having to deal with sky-high rates.
• This is because shorter introductory periods reduce a lender’s risk if rates unexpectedly rise.
• As an added bonus, FHA 3-year ARMs have low down payment requirements ― just 3.5%.
• Most ARMs feature low initial or “teaser” ARM rates that are fixed for a set period of time lasting three, five or seven years.

Kim Porter is an expert on credit, mortgages, student loans, and debt management. Yes, if your ARM loan comes with a “conversion option.” Lenders may offer this choice with conditions and potentially an extra cost, allowing you to convert your ARM loan to a fixed-rate loan. An ARM doesn’t make sense if you’re buying or refinancing your “forever home” or if you can only afford the teaser rate.

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Instead of refinancing from an adjustable-rate mortgage to a fixed-rate, they’ll refinance to an ARM, such as a 3/1 ARM. It might be a good move for short-term lower interest rates if you plan on moving in a few years. But if you’re refinancing and you want to stay in your house for the remainder of your loan term, getting a 3/1 ARM might not make sense. It’s important to run the numbers to see both the costs and the potential savings of either option. An adjustable-rate mortgage (ARM) is a type of mortgage where the interest rate can change at regular intervals following an initial fixed period. With a 3/1 ARM, the initial interest rate remains fixed for three years.

A 5/1 ARM, for example, has a fixed rate for five years, while a 3/6 ARM has a fixed rate for three. After that fixed-rate period, your lender will adjust your interest rate on a scheduled basis for the remainder of your 30-year loan term. With an interest-only loan you are paying only the interest for the initial 3 year period. Your payment is smaller for the initial period, but you aren’t paying back any principle. With some I-O mortgages the interest rate is adjusting during the initial I-O period, which gives a potential for negative amortization.

You take out a home loan with a fixed interest rate, and you make a monthly mortgage payment to your lender. Eligible military borrowers have extra protection in the form of a cap on yearly rate increases of 1 percentage point for any VA ARM product that adjusts in less than five years. Before the 2008 housing crash, lenders offered payment option ARMs, giving borrowers several options for how they pay their loans.

If you do that, you can pretty much shop for the ARM in the same way that you’d compare fixed-rate home loans. This loan type offers lower introductory rates and payments but still comes with the security of a fully-amortized schedule that starts paying down your loan balance from day one. The “fully-indexed rate” on an ARM is the highest rate your loan has the potential to reach when it adjusts. Lenders set an ARM rate cap that determines how high your fully-indexed rate could go if interest rates were to rise substantially. Your margin will be set by several factors such as your credit score and credit history, the lender’s standard margin, and broader real estate market conditions.

What is an adjustable-rate mortgage (ARM)?

Further variations include FHA ARMs and VA ARMs, which are basically the government-backed versions of a conventional ARM, with their own set of qualifications. These are ARMs that allow you to convert your balance to best 3 year fixed rate mortgage a fixed rate, usually for a fee. In general, each type of loan has a different repayment and risk profile. The following graph is for a 5/1 ARM, but it does a good job of showing how payments can change over time.

ARMs can affect your buying power

Then, based on several factors, the rate may increase or decrease once a year for the rest of your loan term. It allows you to choose among four types of payment types in any given month. Generally these types of loans, while offering some flexibility to those with uneven incomes, have the greatest potential downside, since the potential for negative amortization is great.

• These are ARMs that allow you to convert your balance to a fixed rate, usually for a fee.
• The following table shows current 30-year mortgage rates available in New York.
• Some types of 3-year mortgages have the potential for negative amortization.
• Let’s say that after the initial three-year period ends, the rate on your 3/1 ARM increases by 2% to 8.63%.
• When data on any of the above four factors was unavailable for cities, we excluded these from our final rankings of healthiest markets.
• Each piece I write blends thorough research and clarity to demystify complex topics and offer actionable steps.
• We are compensated in exchange for placement of sponsored products and services, or by you clicking on certain links posted on our site.

If you still have the ARM loan when the adjustment period begins, your rate could increase. A 5/1 ARM, for example, comes with a five-year initial period during which the rate is fixed. A 3/1 ARM means you have a fixed interest rate for three years, and your interest rate adjusts each year after that. Generally speaking, a shorter fixed-rate period will get you a lower starting interest rate. A 3/6 ARM, for instance, will usually have a lower initial interest rate than a 7/1 ARM, and a 7/1 ARM will have a lower rate than a 10/1 ARM.

Our scoring formula weighs several factors consumers should consider when choosing financial products and services. The lender uses these numbers to calculate your new payment so you pay off the loan by the end of the 30-year term. If the latest interest rate is higher or lower, your monthly payment will adjust up or down. A 7-year Adjustable Rate Mortgage (ARM) is a home loan with an interest rate that stays the same for the first seven years, followed by adjustments every six months.

However, it cannot increase by more than 5% above the start rate over the life of the loan. Lifetimes caps can be expressed as a specific interest rate — for instance, 7.5 percent. They may also be defined as a percentage point over the start rate — for instance, five percentage points over your start rate. The ARM’s lower start rate is your reward for taking some of the risk normally borne by the lender — the chance that mortgage interest rates may rise a few years down the road. Similarly, the rates of a 10/1 ARM are fixed for the first 10 years and will adjust annually for the remaining life of the loan. Whereas a 5/6 ARM has a fixed interest rate for the first five years but will adjust every six months.

The choices included a principal and interest payment, an interest-only payment or a minimum or “limited” payment. You may prefer the 3-year ARM if you want to take advantage of lower initial interest rates and save money at the start of your loan term. During the introductory period, ARM rates are typically lower than their fixed-rate counterparts.

To figure out if you’ll save money, compare 3/1 ARM interest rates with 30-year fixed rates. Ask the lender which index influences the ARM interest rates and whether the loan comes with rate caps. By taking out a 3/1 ARM, your home costs might be cheaper for a few years.

On a 30-year mortgage, the adjustable period lasts for 27 years― the rest of the loan term. A 3/1 adjustable-rate mortgage (ARM) is a type of home loan that has a fixed interest rate for an introductory period, then a variable rate once the intro period ends. With a lower initial interest rate than a 30-year fixed, you can enjoy reduced monthly payments in the first seven years, saving you significant money. Interest-only ARMs are adjustable-rate mortgages in which the borrower only pays interest (no principal) for a set period. Once that interest-only period ends, the borrower starts making full principal and interest payments. The loan starts with a fixed interest rate for a few years (usually three to 10), and then the rate adjusts up or down on a preset schedule, such as once per year.

The lowest 3/1 ARM mortgage rates are typically reserved for the folks with the best financial track records. In other words, these folks have income stability, plenty of cash savings and high credit scores. That means that for 27 years, these homeowners have to deal with fluctuating interest rates that could make their mortgage payments expensive if rates climb. When the initial fixed-rate period ends, the adjustable-rate repayment period begins.

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