What Is A 3 1 Adjustable-Rate Mortgage ARM?

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.

Current Mortgage Rates by State

But some ARM loans reset every six months or only once every five years. If you take on a 3/1 adjustable-rate mortgage (ARM), you’ll have three years of a fixed mortgage rate, followed by 27 years of interest rates that adjust on an annual basis. Once the three-year introductory period ends, interest rates can either go up or down depending on what’s happening to the major mortgage index that the mortgage is connected to.

Current 3/1 ARM rates

• 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.
• An ARM payment increase could stretch your budget thin, especially if your income has dropped or you’ve taken on other debt.
• The foreclosure wave that followed prompted the federal government to heavily restrict this type of ARM, and it’s rare to find one today.
• ARM lenders may require a higher credit score, larger down payment or restrict the amount of equity you can tap.
• An ARM is an excellent choice if you prioritize lower initial payments and have a clear plan for the future.
• If you choose a 30-year fixed-rate mortgage, for example, your interest rate won’t change for those 30 years.
• However, if you’re going to stay in your home for decades, an ARM can be risky.

One of the things to assess when looking at adjustable rate mortgages is whether we’re likely to be in a rising rate market or a declining rate market. A loan tied to a lagging index, such as COFI, is more desirable when rates are rising, since the index rate will lag behind other indicators. During periods of declining rates you’re better off with a mortgage tied to a leading index. But due to the long initial period of a 3/1 ARM, this is less important than it would be with a 1 year ARM, since no one can accurately predict where interest rates will be three years from now. With a 3/1 loan, though the index used should be factored in, other factors should hold more weight in the decision of which product to choose. Most borrowers take fixed-rate mortgages because the monthly payments often end up lower over time compared to an ARM, and the fixed rate makes it much easier to budget.

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However, some borrowers who had 3/1 ARMs in the past may still be paying them off.

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After this fixed period, the rate becomes variable, changing once per year. The first adjustment is capped at 5%, limiting the increase in the interest rate and reducing the risk of payment shock. The margin acts as the floor, meaning the interest rate can never be lower than 3%, no matter how much the index rate decreases.

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

To help you find the right one for your needs, use this tool to compare lenders based on a variety of factors. Bankrate has reviewed and partners with these lenders, and the two lenders shown first have the highest combined Bankrate Score and customer ratings. You can use the drop downs to explore beyond these lenders and find the best option for you. For instance, if you expect to own your house for only three to five years, look at 3/1 and 5/1 ARMs. 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.

How to compare mortgage offers

• Adjustable-rate mortgages (ARMs) can come with starting rates that are lower than comparable 30-year fixed mortgage rates.
• Still, that low rate equates to lower mortgage payments for the first three to 10 years of your mortgage loan.
• Lenders nationwide provide weekday mortgage rates to our comprehensive national survey.
• At each rate adjustment, the lender will add your margin to your index rate to get your new mortgage rate.
• 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.
• It’s common for homeowners to refinance into a fixed-rate mortgage before their ARM’s first adjustment.

After seven years, your payments will fluctuate every six months based on the new interest rate. The 5/1 ARM is virtually identical to the 7/1 ARM, except that the start rate will adjust after the first five years, rather than seven years. In addition, the intro rate on a 7/1 ARM will be higher than on a 5/1 ARM because you get to hold onto the fixed rate for a longer time. The minimum credit score and the maximum debt-to-income ratio that you’re required to have will vary depending on your mortgage lender. But if your FICO credit score is below 620, you might not be able to qualify for a conventional loan. That means that you might only be able to get a mortgage that’s backed by the FHA (first-time homebuyers) or the USDA (those buying a home in a rural area).

Is an adjustable rate a bad idea?

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.

• For instance, the APR calculation for a 3/1 ARM assumes that after the first three years, the loan increases to its fully-indexed rate, or rises as high as it’s allowed to under the loan’s terms.
• In general, each type of loan has a different repayment and risk profile.
• Because you’ll have a lower interest rate than your neighbors with fixed-rate mortgages, you won’t be paying very much interest in the beginning.
• Yes, you can refinance an ARM just as you can any other mortgage loan.

Editorial Independence

• 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.
• Not having a prepayment penalty allows you to pay off your mortgage early if you are ever able.
• APRs and rates are based on no existing relationship or automatic payments.
• This typically lasts 3, 5, 7, or 10 years, with a 5-year fixed intro rate being the most common.
• A 3/1 ARM, or adjustable-rate mortgage, is a 30-year, fully-amortizing mortgage with a low, fixed introductory rate for the first three years.
• So after the 5-year fixed-rate period, your rate can adjust once per year for the next 25 years, or until you refinance or sell the home.
• 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.
• 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.

Interest-only loans can give you even lower starting monthly payments than typical ARMs. But your monthly payments will go up once principal payments and rate adjustments kick in. Here’s a comparison of ARM loan payments 3 year fixed rate mortgage against the two most popular types of fixed-rate mortgages, with all other things being equal, assuming an adjustment to the maximum payment cap. I’ve covered mortgages, real estate and personal finance since 2020.

When should you consider a 3-year ARM?

The “limited” payment allowed you to pay less than the interest due each month — which meant the unpaid interest was added to the loan balance. When housing values took a nosedive, many homeowners ended up with underwater mortgages — loan balances higher than the value of their homes. The foreclosure wave that followed prompted the federal government to heavily restrict this type of ARM, and it’s rare to find one today. In order for this to happen, mortgage rates would need to drop, bringing the index used to calculate your ARM’s rate down in tandem. A 5/1 ARM rate gives you an initial rate that’s fixed for five years, and then adjusts every year for the rest of the loan’s term. ARM lenders may require a higher credit score, larger down payment or restrict the amount of equity you can tap.

Then, it can change in one-year intervals for the rest of the loan term. It’s common for homeowners to refinance into a fixed-rate mortgage before their ARM’s first adjustment. That way, they never have to deal with the risk of expensive rate adjustments and can enjoy stable payments over the life of the loan. 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.

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. An adjustable-rate mortgage is a home loan with an interest rate that changes during the loan term. Most ARMs feature low initial or “teaser” ARM rates that are fixed for a set period of time lasting three, five or seven years. If you expect a promotion or higher-paying job, you may not mind the higher monthly payments that come after your fixed-rate period ends. A one-time windfall, like an inheritance, can also let you pay off your mortgage before the higher monthly payments start.

Fixed-Rate & Adjustable-Rate Loans

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.

What Are The Benefits of a 3-Year Mortgage?

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.

How ARM rates work

Bankrate has helped people make smarter financial decisions for 40+ years. Our mortgage rate tables allow users to easily compare offers from trusted lenders and get personalized quotes in under 2 minutes. While our priority is editorial integrity, these pages may contain references to products from our partners. Your payments may fluctuate every 6 months based on the current loan balance, new interest rate, and remaining loan term. However, if you’re going to stay in your home for decades, an ARM can be risky. If you don’t refinance, your mortgage payments may rise significantly once the fixed-rate period ends.

Mortgage Tools

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.

Compare ARM rates

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.

A 3-Year ARM mortgage can offer initial affordability and flexibility, yet it demands careful consideration and planning. Understanding its features, advantages, and potential risks is crucial for borrowers aiming to leverage this mortgage option effectively. Generally, the initial interest rate on an ARM mortgage is lower than that of a comparable fixed-rate mortgage. After that period ends, interest rates — and your monthly payments — can rise or fall.

Just three years later in 2019, rates rose over a full percentage point to 4.18%. Then, go over your budget and figure out if you can afford to pay the mortgage at its peak rate. If you can’t afford that payment, then an ARM may not be a good choice for you.

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.

For instance, the APR calculation for a 3/1 ARM assumes that after the first three years, the loan increases to its fully-indexed rate, or rises as high as it’s allowed to under the loan’s terms. It also assumes you’d keep that rate for the remaining 27 years of its term. ARM rates are more complicated than those of fixed-rate mortgages, so shopping for them is a little different also. The 10/1 ARM gives you a low fixed rate for a decade and 20 potential rate adjustments, while a 5/1 ARM only locks your interest rate for five years and has 25 potential rate adjustments. The interest rate on any ARM is tied to an index rate, often the Secured Overnight Financing Rate (SOFR).

• These adjustments can lead to fluctuations in monthly mortgage payments, making it crucial for borrowers to comprehend the workings of ARM rates.
• Your payments may fluctuate every 6 months based on the current loan balance, new interest rate, and remaining loan term.
• When the initial fixed-rate period ends, the adjustable-rate repayment period begins.
• For instance, if you expect to own your house for only three to five years, look at 3/1 and 5/1 ARMs.
• The 5/1 ARM is virtually identical to the 7/1 ARM, except that the start rate will adjust after the first five years, rather than seven years.

The variable rate is tied to a benchmark, typically the Secured Overnight Financing Rate (SOFR). This rate moves based on what’s happening in the economy in the U.S. and abroad, and how the Federal Reserve and other central banks are responding to those trends. Affordability accounted for 40% of the healthiest markets index, while each of the other three factors accounted for 20%. When data on any of the above four factors was unavailable for cities, we excluded these from our final rankings of healthiest markets. The LIBOR — once a popular index for mortgages — was phased out and replaced by Secured Overnight Financing Rate (SOFR) as of June 30, 2023. As an added bonus, FHA 3-year ARMs have low down payment requirements ― just 3.5%.

A fixed-rate mortgage (FRM) has a rate that stays the same over the life of the loan. Its rate will never increase or decrease, which also means your mortgage payment will never change. If you claim the mortgage interest deduction with a 3/1 ARM, don’t be surprised if your tax savings are relatively low, at least for the first three years of your loan term. Because you’ll have a lower interest rate than your neighbors with fixed-rate mortgages, you won’t be paying very much interest in the beginning. Before you apply for an adjustable-rate mortgage, it’s best to compare all of the available mortgage rates. That way you can make sure you’re getting the best deal on your home loan.

But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you. 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. When compared to other types of mortgages, ARMs typically have stricter requirements. That’s because lenders need to consider your ability to repay the loan if your rate moves higher. If you found this guide helpful you may want to consider reading our comprehensive guide to adjustable-rate mortgages.

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.

Only when you’ve determined you can live with all these factors should you be comparing initial rates. These introductory low rates entice buyers with lower monthly payments throughout the initial fixed period. Without these start rates, few would ever choose an ARM over an FRM. Let’s say that after the initial three-year period ends, the rate on your 3/1 ARM increases by 2% to 8.63%. With 27 years and roughly $173,564 left on the mortgage, your payments would now be $1,249.

The following table compares ARM rates to rates on other types of loans. The main risk with an ARM is that the rate will increase along with your monthly payments. The lender repeats the steps to adjust the interest rate and calculate the monthly payment every six months. A payment-option ARM, however, could result in negative amortization, meaning the balance of your loan increases because you aren’t paying enough to cover interest. If the balance rises too much, your lender might recast the loan and require you to make much larger, and potentially unaffordable, payments. 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.

Bankrate.com is an independent, advertising-supported publisher and comparison service. We are compensated in exchange for placement of sponsored products and services, or by you clicking on certain links posted on our site. While we strive to provide a wide range of offers, Bankrate does not include information about every financial or credit product or service. When fixed-rate mortgage rates are high, lenders may start to recommend adjustable-rate mortgages (ARMs) as monthly-payment saving alternatives.