Types of Home Mortgages: 3/1 ARMs

An Overview of 3/1 ARMs

The 3/1 adjustable rate mortgage—also more simply called the three-year ARM—is a home loan that has a fixed interest rate for three years and below the market rates. From the fourth year on, it turns into an adjustable mortgage. The rate is usually derived from the treasury index plus a margin. There is, of course, a cap involved in the rising interest rates as with all ARM loans.

The Popularity of 3/1 ARMs

These ARM loans are popular because they carry a lower interest rate at the beginning of the loan, and the monthly payments will be lower. The buyer can qualify for a larger loan that the traditional 30-year fixed rate mortgage. With the 3/1 ARM, the initial payments are fixed (because the interest rate is fixed over the first three years), and the borrower is able to save money or pay down some of the principal if possible.

When ARMs are Helpful

The ARM can also help buyers qualify if they have lower down payments because they can qualify for a larger loan. Again, over the three-year initial phase of the loan, the buyer can sock away money or pay down the principal with the extra money if there is any after other living expenses.

What Happens at the End of Three Years

After the initial three years, the interest rate changes according to market conditions and rates. They usually change every 12 months, but some change every six. These rates have caps, or limits, to how much they can change per period, as well as limits on the total they can change over the remained of the loan.

However, a buyer still has to be prepared for the increase in payments. Because it’s unknown what interest rates will do in three years—or after that—the borrower is sometimes left with surprises at the end of the three year initial period. Buyers should always be sure they can handle any possibilities by the end of that period, and plan for the worst. That way, if the worst never comes they have some money saved and a good income for other things. If it does come, they will be comfortably prepared.

Do Your Homework and Consider Your Options

The ARM loan in any form is not for everyone, but if you think it can help you qualify for the home you want, make sure you ask your lender questions and be satisfied with the answers before you sign anything. If you think your lender is not being straight with you regarding the ARM, or you don’t feel comfortable with the information, talk to other lenders.