You need to understand what a 3/27 adjustable-rate mortgage is. Here’s what to know.

## What is a 3/27 adjustable-rate mortgage?

A 3/27 adjustable-rate mortgage is a 30-year loan product that has a fixed introductory rate for the first three years. Usually, the initial interest rate is below the prevailing market rate. After the three-year intro term, the loan rate adjusts annually for the remaining 27 years.

## Deeper definition

The 3/27 adjustable-rate mortgage, also known as a 3/27 ARM, offers a cheap payment for the first three years of the loan. However, once the loan’s interest rate starts to reset, the payment may increase dramatically, making it important for borrowers to understand how the loan resets and what the maximum payment is.

Ideally, borrowers would have the ability to pay the maximum payment. Some mortgages have rules that restrict how much the interest rate may rise at one time or over the life of the loan.

Lenders base the variable interest rate for the 3/27 ARM on a stated index, like Libor or one-year Treasury bill yield. This portion of the interest rate changes due to fluctuations in the index. The lender also adds a specified margin to the index. Together, this is the spread that determines the interest rate.

You should plan to refinance your 3/27 ARM before it resets. However, some ARMs have costly prepayment penalties that make refinancing unaffordable.

If you plan to live in your home for a short period of time, you may prefer the initial affordability of a 3/27 adjustable-rate mortgage. For example, a 3/27 ARM may have an introductory rate of 4 percent. However, when it resets for the first time, the payment may increase by 1 percent to 2 percent. Though an extra percent doesn’t sound like a big deal, if you have a \$150,000 mortgage, it increases the monthly payment from \$716.12 to \$798.

Run the numbers with Bankrate’s mortgage calculators to find the mortgage that works for your financial situation.

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