It’s important to know how the loan is structured, and how it’s amortized during the initial 3-year period & beyond. Adjustable-rate mortgages (ARMs) can come with starting rates that are lower than comparable 30-year fixed mortgage rates. When mortgage rates rise, borrowers are often drawn to the temporary payment savings offered by initial ARM rates. Buyers like 3-year ARMs because the initial fixed rate is often lower than rates for other kinds of mortgages. But once the adjustable rate kicks in, you can expect higher monthly payments (though within certain limits). An adjustable-rate mortgage is a type of mortgage loan with an interest rate that adjusts or changes, up and down, as it follows wider financial market conditions.

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Interest-only loans can give you even lower starting monthly payments than typical ARMs. But your monthly payments will go up once principal payments and rate adjustments kick in. Here’s a comparison of ARM loan payments against the two most popular types of fixed-rate mortgages, with all other things being equal, assuming an adjustment to the maximum payment cap. I’ve covered mortgages, real estate and personal finance since 2020.

Is an adjustable rate a bad idea?

Just three years later in 2019, rates rose over a full percentage point to 4.18%. Then, go over your budget and figure out if you can afford to pay the mortgage at its peak rate. If you can’t afford that payment, then an ARM may not be a good choice for you.

Payment option ARM loans

Our scoring formula weighs several factors consumers should consider when choosing financial products and services. The lender uses these numbers to calculate your new payment so you pay off the loan by the end of the 30-year term. If the latest interest rate is higher or lower, your monthly payment will adjust up or down. A 7-year Adjustable Rate Mortgage (ARM) is a home loan with an interest rate that stays the same for the first seven years, followed by adjustments every six months.

How to Evaluate a 3-Year ARM Mortgage

Kim Porter is an expert on credit, mortgages, student loans, and debt management. Yes, if your ARM loan comes with a “conversion option.” Lenders may offer this choice with conditions and potentially an extra cost, allowing you to convert your ARM loan to a fixed-rate loan. An ARM doesn’t make sense if you’re buying or refinancing your “forever home” or if you can only afford the teaser rate.

ARM rate floors

The interest on your loan will be whatever the index rate is, plus a margin the lender adds. To make sure you can repay the loan, some ARM programs require that you qualify at the maximum possible interest rate based on the terms of your ARM loan. An ARM payment increase could stretch your budget thin, especially if your income has dropped or you’ve taken on other debt.

• That’s about $96 more a month, and when compared with your monthly payment for a 30-year fixed-rate mortgage, it’s $2,940 more a year.
• The “limited” payment allowed you to pay less than the interest due each month — which meant the unpaid interest was added to the loan balance.
• This rate moves based on what’s happening in the economy in the U.S. and abroad, and how the Federal Reserve and other central banks are responding to those trends.
• With an interest-only loan you are paying only the interest for the initial 3 year period.
• Let’s say you’re looking to buy a home worth $200,000 with a 20% down payment.

Current ARM mortgage rates

• After seven years, your payments will fluctuate every six months based on the new interest rate.
• With a lower initial interest rate than a 30-year fixed, you can enjoy reduced monthly payments in the first seven years, saving you significant money.
• Bankrate has reviewed and partners with these lenders, and the two lenders shown first have the highest combined Bankrate Score and customer ratings.
• I’ve covered mortgages, real estate and personal finance since 2020.
• The ARM’s lower start rate is your reward for taking some of the risk normally borne by the lender — the chance that mortgage interest rates may rise a few years down the road.
• If you take out a 3/1 ARM, you’ll receive a fixed rate for the first three years of the loan.
• Hybrid mortgages, like a 3/1 ARM, provide a variety of benefits, but come also with downsides.

If you do that, you can pretty much shop for the ARM in the same way that you’d compare fixed-rate home loans. This loan type offers lower introductory rates and payments but still comes with the security of a fully-amortized schedule that starts paying down your loan balance from day one. The “fully-indexed rate” on an ARM is the highest rate your loan has the potential to reach when it adjusts. Lenders set an ARM rate cap that determines how high your fully-indexed rate could go if interest rates were to rise substantially. Your margin will be set by several factors such as your credit score and credit history, the lender’s standard margin, and broader real estate market conditions.

Fully-indexed rate

The variable rate is tied to a benchmark, typically the Secured Overnight Financing Rate (SOFR). This rate moves based on what’s happening in the economy in the U.S. and abroad, and how the Federal Reserve and other central banks are responding to those trends. Affordability accounted for 40% of the healthiest markets index, while each of the other three factors accounted for 20%. When data on any of the above four factors was unavailable for cities, we excluded these from our final rankings of healthiest markets. The LIBOR — once a popular index for mortgages — was phased out and replaced by Secured Overnight Financing Rate (SOFR) as of June 30, 2023. As an added bonus, FHA 3-year ARMs have low down payment requirements ― just 3.5%.

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So after the 5-year fixed-rate period, your rate can adjust once per year for the next 25 years, or until you refinance or sell the home. Almost all ARM loans today are “hybrid ARMs.” These have an initial period of 3-10 years where the interest rate is fixed. In fact, these initial introductory rates — sometimes called “teaser rates” — are often lower than those of a fixed-rate loan. With a 3/1 ARM, your mortgage rate is fixed for three years and then adjusts once a year for the rest of the loan term. At the beginning of your mortgage, ARMs work just like fixed-rate loans.

Editorial Independence

Even with an interest rate cap in place, managing your money and sticking to a budget can be difficult when you’re not sure how much your mortgage will cost you. That’s the biggest drawback of having an adjustable-rate mortgage. One way to look at it is if you were buying a home for $225,000 with 20% down.

Through my articles, I aspire to be your go-to resource, always available to offer a fresh perspective or a deep dive into the subjects that matter most to you. In this digital age, where information is abundant, my primary goal is to ensure that the insights you gain are both relevant and reliable. Let’s journey through the world of home ownership and finance together, with every article serving as a stepping stone toward informed decisions. Still, that low rate equates to lower mortgage payments for the first three to 10 years of your mortgage loan. And with fixed rates on the rise, many borrowers can benefit from the low intro payments on an ARM.

Whether you’re just comparing 3 year ARM rates or ready to get started on a mortgage, we can help make the process of refinancing or buying a home fast and easy. The index rate can change, but the margin stays the same each time the rate resets. There are also limits — or caps — to how much the interest rate can increase. ARM loan guidelines require a 5% minimum down payment, compared to the 3% minimum for fixed-rate conventional loans. In contrast to a 3/1 ARM, a fixed-rate mortgage keeps the same interest rate for the life of the loan. If you choose a 30-year fixed-rate mortgage, for example, your interest rate won’t change for those 30 years.

✍ Editor’s note: Lenders have replaced 3/1 ARM offerings with 3/6 ARMs

And since you’ll pay off your current mortgage when you sell, you won’t have to worry about higher ratesand payment amounts. The table below is updated daily with 3-year ARM rates for the most common types of home loans. Compare week-over-week changes to current adjustable-rate mortgages and annual percentage rates (APR). The APR includes both the interest rate and lender fees for a more realistic value comparison. ARMs come with rate caps that insulate you from possible steep year-to-year increases in monthly payments.

These caps limit the amount by which rates and payments can change. This can help you understand what your ARM would look like if rates were to spike and stay high. But keep in mind that this scenario is unlikely and you probably won’t pay the highest possible rate over your loan term. In addition, many borrowers move or refinance before the ARM fixed-rate period is up and never have to pay the higher payments that come with a fully-indexed rate. The 5/1 ARM will offer a fixed interest rate for the first five years of the loan term, while the 3/1 has a fixed rate for only the first three years. Once these teaser rates expire, the ARM will reset and be subject to interest rate adjustments for the remaining 25 or 27 years of the 30-year mortgage.

These limit how much your lender can change your interest rate, usually both at each adjustment interval and over the life of your loan. Adjust the graph below to see 3-year ARM rate trends tailored to your loan program, credit score, down payment and location. After the fixed-rate period, the lender adds the SOFR index to the 3% margin to get the new interest rate. Let’s say you took out a 30-year 5/1 ARM for $350,000 with an introductory rate of 6.65 percent (the average rate as of this writing). Here’s how your payment schedule might look, assuming interest rates rose annually by. If your mortgage loan has a floor of three percentage points, your interest rate will never drop below 3%, even if its fully-indexed rate is lower.

But if the rate increases, your monthly mortgage payments will also rise. A 3/1 ARM can be a good idea if you plan to refinance your home before the fixed period expires. Low initial rates can translate to lower monthly payments during the first few years of your mortgage. With a fixed-rate mortgage, you’ll have consistent, predictable monthly payments throughout the life of your loan. A 3-year ARM has a fixed “teaser” interest rate for the first three years of the loan. After that, the interest rate adjusts on a recurring schedule, typically every six months.

An adjustable-rate mortgage, or ARM, is a home loan that has an initial, low fixed-rate period of several years. After that, for the remainder of the loan term, the interest rate resets at regular intervals. The caps on your adjustable-rate mortgage are the first line of defense against massive increases in your monthly payment during the adjustment period. They come in handy, especially when rates rise rapidly — as they have the past year. The graphic below shows how rate caps would prevent your rate from doubling if your 3.5% start rate was ready to adjust in June 2023 on a $350,000 loan amount. With this type of mortgage, the actual indexed rate is fixed for the first three years of the loan, and then adjusts every year thereafter, a sort of hybrid between a fixed rate and an adjustable rate.

At Bankrate, I’m focused on all of the factors that affect mortgage rates and home equity. I enjoy distilling data and expert advice into takeaways borrowers can use. Prior to Bankrate, I wrote and edited for Rocket Mortgage/Quicken Loans.

To figure out if you’ll save money, compare 3/1 ARM interest rates with 30-year fixed rates. Ask the lender which index influences the ARM 3 year arm rates today interest rates and whether the loan comes with rate caps. By taking out a 3/1 ARM, your home costs might be cheaper for a few years.

One of the things to assess when looking at adjustable rate mortgages is whether we’re likely to be in a rising rate market or a declining rate market. A loan tied to a lagging index, such as COFI, is more desirable when rates are rising, since the index rate will lag behind other indicators. During periods of declining rates you’re better off with a mortgage tied to a leading index. But due to the long initial period of a 3/1 ARM, this is less important than it would be with a 1 year ARM, since no one can accurately predict where interest rates will be three years from now. With a 3/1 loan, though the index used should be factored in, other factors should hold more weight in the decision of which product to choose. Most borrowers take fixed-rate mortgages because the monthly payments often end up lower over time compared to an ARM, and the fixed rate makes it much easier to budget.

• If you’re afraid that you’ll get stuck with a high interest rate beginning with the 37th month of your loan term, you can try to refinance for a fixed-rate mortgage.
• Bankrate.com is an independent, advertising-supported publisher and comparison service.
• Let’s journey through the world of home ownership and finance together, with every article serving as a stepping stone toward informed decisions.
• The interest on your loan will be whatever the index rate is, plus a margin the lender adds.
• But three years into the mortgage, the lender might adjust your interest rate — along with your mortgage payment.
• Only when you’ve determined you can live with all these factors should you be comparing initial rates.

Not having a prepayment penalty allows you to pay off your mortgage early if you are ever able. Interest rate caps save many homeowners with 3/1 ARMs from having to deal with sky-high rates. These caps limit how much interest rates can increase once interest rates adjust. There are interest rate caps that limit how high interest rates can climb each year as well as ones that prevent interest rates from rising too much over the course of the entire loan term.

The most common initial fixed-rate periods are three, five, seven and 10 years. Occasionally the adjustment period is only six months, which means after the initial rate ends, your rate could change every six months. The best way to get an idea of how an ARM can adjust is to follow the life of an ARM.

A 5/1 ARM, for example, has a fixed rate for five years, while a 3/6 ARM has a fixed rate for three. After that fixed-rate period, your lender will adjust your interest rate on a scheduled basis for the remainder of your 30-year loan term. With an interest-only loan you are paying only the interest for the initial 3 year period. Your payment is smaller for the initial period, but you aren’t paying back any principle. With some I-O mortgages the interest rate is adjusting during the initial I-O period, which gives a potential for negative amortization.

But some ARM loans reset every six months or only once every five years. If you take on a 3/1 adjustable-rate mortgage (ARM), you’ll have three years of a fixed mortgage rate, followed by 27 years of interest rates that adjust on an annual basis. Once the three-year introductory period ends, interest rates can either go up or down depending on what’s happening to the major mortgage index that the mortgage is connected to.

Generally, the longer the introductory period, the higher the interest rate will be during that window. For example, a 3/1 ARM will likely come with a lower introductory rate than a 7/1 ARM. Borrowers who plan to move, upgrade, or downsize within 5 to 10 years often benefit from ARMs. For instance, a family expecting to relocate in 6 years could use a 7/6 ARM to secure a lower rate without worrying about future adjustments. The lender sets the margin, which doesn’t change for the life of the loan. There are a few factors that go into setting an ARM’s variable rate, so it’s important to understand what they are.

• On the other hand, if you have a lot of cash on-hand, you can make a big down payment and buy mortgage points.
• Also referred to as a “teaser rate” or “intro rate,” your start rate is the ARM’s initial interest rate.
• With a 3/1 loan, though the index used should be factored in, other factors should hold more weight in the decision of which product to choose.
• While we strive to provide a wide range of offers, Bankrate does not include information about every financial or credit product or service.
• An adjustable-rate mortgage makes sense if you have time-sensitive goals that include selling your home or refinancing your mortgage before the initial rate period ends.
• The following table shows the rates for Los Angeles ARM loans which reset after the third year.
• Low initial rates can translate to lower monthly payments during the first few years of your mortgage.

That’s about $96 more a month, and when compared with your monthly payment for a 30-year fixed-rate mortgage, it’s $2,940 more a year. That difference could impact you financially, especially if your budget is tight. It’s something to keep in mind as you check your finances before deciding on a mortgage. Every time your lender adjusts your interest rate, they’ll also recalculate the mortgage payment so you pay off the loan by the end of your term. 3-year ARMs, like other ARM loans, are based on various indices, so when the general trend is for upward rates, the teaser rates on adjustable rate mortgages will also rise.