Current 3/1 ARM rates

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What is a 3/1 ARM?
How does a 3/1 ARM work?
When should you consider a 3/1 ARM?

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What is a 3/1 ARM?

A 3/1 ARM, or adjustable-rate mortgage, is a type of 30-year mortgage that has a fixed interest rate for the first three years and an adjustable (or variable) interest rate for the remaining 27.

The “3” in 3/1 indicates the fixed-rate period, or three years. The “1” indicates the frequency the rate will adjust after that period, or once a year.

With any type of ARM, if your rate decreases, your monthly payment will, too. Likewise, if your rate goes up, you’ll have to pay more. There is usually a cap on how much your rate can increase, but sometimes that cap doesn’t apply to the first adjustment after the fixed period. This can make an ARM difficult for some borrowers to afford if the rate jumps substantially.

How does a 3/1 ARM work?

During the first three years of a 3/1 ARM term, the interest rate remains the same. After that, the rate changes each year.

How the rate changes — either up or down — is based on an index, such as the 11th Federal Home Loan Bank District Cost of Funds Index (COFI), LIBOR or the yield on the one-year Treasury bill. You can check your loan documents to see which index your mortgage follows.

That’s not the only factor, however. Mortgage lenders also account for a margin, which some lenders base on your credit. This margin typically stays the same over the life of your loan. Together with the index, the margin helps determine your new rate.

You can use Bankrate’s ARM calculator to see how rate changes impact your monthly payment and the overall cost of your loan.

When should you consider a 3/1 ARM?

In general, ARMs have lower interest rates initially compared to a fixed-rate mortgage, so they can be attractive for borrowers looking for lower monthly payments upfront. The savings from those first three years of a 3/1 ARM can be put toward a higher-yield investment or other financial goal.

A 3/1 ARM can be a good idea if you know you won’t live in the home long-term. The ARM allows you to take advantage of a lower interest rate, then sell before the rate potentially increases to an unaffordable level. Some ARMs have a prepayment penalty if you sell too soon, however, so keep that mind.

With an ARM, a borrower might be able to buy a more expensive property, as well. This is because the lender factors the lower monthly payment into the borrower’s debt-to-income ratio calculations, increasing what they can afford.

After the three-year mark, though, your rate can rise. If you’d prefer more stability in your budget and predictable payments — and you plan to stay in the home for a while — a 3/1 ARM might not be the best choice for you.

Learn more about adjustable-rate mortgages

Written by: Jeff Ostrowski, Senior Mortgage Reporter for Bankrate

Jeff Ostrowski covers mortgages and the housing market. Before joining Bankrate in 2020, he wrote about real estate and the economy for the Palm Beach Post and the South Florida Business Journal.