What is a 3/27 Adjustable-Rate Mortgage?
A 3/27 adjustable-rate mortgage (ARM) is a 30-year home loan with a unique structure: it has an initial three-year period where the interest rate is fixed, followed by a 27-year period where the interest rate becomes variable. This mortgage type is often utilized for short-term financing with plans for refinancing into more stable terms later.
How Does a 3/27 ARM Work?
With an ARM, notably the 3/27 ARM, the interest rate is fixed for the first three years—a period in which the rate is typically lower than market interest rates for conventional 30-year mortgages. After these three years, the interest rate adjusts based on a benchmark index like the yield on one-year U.S. Treasury bills.
Lenders add a margin to this index, determining the total interest rate you’ll actually pay, known as the fully indexed interest rate. While this rate often rises, these loans generally include caps to limit how much the rate can increase during each adjustment period and over the total loan duration.
Example of a 3/27 ARM in Action
Consider a borrower who takes out a $250,000 3/27 ARM with an initial fixed interest rate of 3.5%. For the first three years, their monthly payment would be around $1,123. Post the three-year mark, suppose the benchmark index rate is 3% with a 2.5% margin, leading to a fully indexed rate of 5.5%. In this case, the monthly payment would rise to approximately $1,483—a significant increase, underlining the importance of either preparing for higher payments or refinancing.
The Risks Involved
Key risks with a 3/27 ARM include the potential inability to refinance before the rate adjustment and rising interest rates increasing monthly payments. If the borrower’s credit score drops, or their home loses value, refinancing might not be feasible, leaving them facing higher costs.
Prepayment Penalties
Some ARMs come with prepayment penalties, complicating refinancing plans. It’s crucial to check for these penalties in the lender’s disclosure documents. If prepayment penalties are a concern, negotiate terms removing them or look for other lenders.
Benefits and Strategic Considerations
A 3/27 ARM can offer lower initial monthly payments, making homeownership more affordable in the short term. However, ensuring you can refinance or manage potentially higher payments post the initial period is essential.
Is a 3/27 ARM Right for You?
Before choosing a 3/27 ARM, evaluate your ability to refinance within the initial fixed-rate period. Factors include maintaining a good credit score and a steady income. If uncertain about your future financial security, a more stable loan might be safer.
Frequently Asked Questions
What is a 3/27 adjustable-rate mortgage (ARM)?
A 3/27 ARM has a fixed interest rate for the first three years and a variable rate for the remaining 27 years—it’s a type of hybrid ARM.
What are the advantages of a 3/27 ARM?
The primary benefit is the low initial interest rate, making short-term financing more manageable. However, rates can rise beginning in the fourth year.
Is a 3/27 ARM right for me?
It’s suitable if you’re looking to sell or refinance the home within the first three years. Always seek a loan without prepayment penalties to avoid extra costs when refinancing.
Related Terms: hybrid ARM, fixed-rate mortgage, prepayment penalty, fully indexed interest rate.
