3/1 ARM: 3/1 Adjustable Rate Mortgage in Home Loans
What is a 3/1 ARM?
A 3/1 ARM is an adjustable-rate mortgage in which the rate is fixed for the first three years of the loan. As a hybrid mortgage, it has elements of both a traditional fixed-rate mortgage and an adjustable (or variable) rate loan. As with pretty much all hybrid rate mortgages, the shorter the period of the fixed-rate part of the loan, the lower the initial interest rate. That’s the bank’s way of compensating you for the increased risk you’re taking on when the adjustable part of the mortgage kicks in.
How often is the rate adjusted on a 3/1 ARM?
A 3/1 ARM rate is adjusted once each year for the remainder of the loan’s duration. When (and if) the interest rate changes, so will the size of your monthly payment. That might seem like a lot of adjustments, but fortunately, ARMs have both lifetime and periodic caps that limit both the maximum interest rate you’ll have to pay and the maximum percentage your interest rate can increase during each adjustment period.
What’s the biggest benefit of a 3/1 ARM?
Lower payments! If you bought a $300,000 house and put down 20%, you’d have to take out a loan for $240,000. While a 30-year fixed rate mortgage might give you an interest rate of 5%, for example, you might be able to get 4% on a 3/1 ARM. While your 30-year fixed rate home loan would give you a monthly payment of around $1,288/month, cutting it down to 4% would take your monthly payment down to around $1,145/month. That means you could potentially save thousands per year-- at least until your adjustable rate kicks in.
When is a 3/1 ARM a good idea?
While it’s a little safer than a pure adjustable-rate mortgage, a 3/1 ARM is still somewhat risky, as far as hybrid mortgages are concerned. And, as with other adjustable-rate mortgage products, a 3/1 ARM could be the smartest if you plan to move or refinance after the three-year fixed-rate period. That way, (if you’re lucky), you can build a little home equity, potentially see the price of your home rise, and get out if you don’t like where interest rates are going after the adjustable-rate portion of your mortgage begins.
What’s the risk of a 3/1 ARM?
Any adjustable rate mortgage is going to be a little riskier than the fixed-rate alternative -- and, if you aren’t careful, your mortgage payments could go sky high! In fact, some people find that their mortgage payments actually double with a 3/1 ARM.
But things aren’t all bad: most ARMs do have a lifetime payment cap that limits just how far your mortgage payment can rise. So, to make sure you’re not getting into anything you won’t be able to handle, make sure to check the lifetime cap on the ARM you’re considering, and make sure that if the worst-case scenario happens, you can still afford it.
While for many, the main benefit of an ARM is being able to get out of it when the adjustable rate begins, some states allow lenders to assess penalty fees if you sell or refinance an ARM during the first 5 years of the loan. This means that if you’re not careful, a nasty fee could eat up a lot of the savings you’ve gained by locking in a low-interest rate.