3-Year ARM Mortgage in the US. Apply online

A 3-year adjustable-rate mortgage, also known as a 3/1 ARM, offers a tempting proposition for homebuyers: a fixed interest rate for the first three years of your loan. During that initial fixed-rate period, you'll have a set monthly payment, which can result in lower closing costs compared to buying a home with a conventional fixed-rate mortgage. But after those three years pass, your 3/1 ARM's interest rate will start adjusting annually. This is where the 3/1 ARM gets interesting — or scary, depending on your situation and how you plan to handle the loan.

How does a 3-year adjustable-rate mortgage work?

A 3-year adjustable-rate mortgage is a hybrid mortgage, since it has a fixed-rate period (three years) before the rate begins adjusting. As with fixed-rate mortgages, 30 years is a common loan term, so 3-year ARMs usually come with a 27-year adjustable-rate period.

During that adjustable period, your 3/1 ARM's interest rate will rise or fall depending on prevailing mortgage interest rates. ARM interest rates are made up of the margin, which is a static base rate, and the index, which can go up or down. Lenders add the index to the margin to determine adjustable mortgage rates. When you're shopping for 3/1 ARMs, you'll see that lenders offer not only different interest rates but also differing parameters for how the loan will work. It's not as if anything can happen once the introductory period is up. Instead, there are caps that show you how much your interest rate might change. These are often presented as sets of three numbers, like 2/2/5. These represent the three caps.

Initial cap. The first number tells you the highest your interest rate could go the first time that it adjusts. In the 2/2/5 example, it's a 2, so the first adjustment can't be more than 2 percentage points. If you started out with a 4% interest rate, the highest interest rate your first adjustment could bring is 6%.
Subsequent/periodic cap. There are different names for this cap, but either way, the middle number represents how much your interest rate could change each time it adjusts after that first reset. With a 2/2/5 ARM, every year your rate can go up as much as 2 percentage points. Continuing the example, say you're at 6% — the highest you can go from that is 8%.
Lifetime cap. The last number gives you the highest that your interest rate could go above your initial rate. Five percentage points are pretty common. With our 2/2/5 example, assuming you'd started out with a 4% introductory rate, your lifetime cap would be 9%.

Knowing these different caps can help you understand what could happen if you end up keeping your 3/1 ARM beyond that initial three years. You can also ask adjustable-rate mortgage lenders to do the math for you and give you actual numbers for what your mortgage payment could be at different interest rates.

Depending on prevailing rates, your interest rate also could adjust downward. This actually can put ARM borrowers in the adjustable period at an advantage, because in a falling rates environment they can get an interest rate decrease without having to refinance. However, lenders may set a floor limiting how much your interest rate can fall if rates are going down.

Features

Initial Fixed Rate Period. With a 3-year ARM, borrowers benefit from a fixed interest rate for the initial three years of the loan term. During this period, monthly mortgage payments remain unchanged, offering stability to homeowners.
Adjustable Interest Rate. Following the initial fixed-rate period, the interest rate on a 3/1 ARM adjusts annually for the remaining loan term. This adjustment is based on predetermined factors such as market indexes, plus a margin set by the lender, potentially leading to fluctuations in monthly payments.
Interest Rate Caps. To mitigate the impact of interest rate fluctuations, 3/1 ARMs often come with interest rate caps, including initial adjustment caps, subsequent adjustment caps, and lifetime rate caps. These caps limit how much the interest rate can increase or decrease at each adjustment period and over the life of the loan, providing borrowers with some level of predictability and protection.
Monthly Mortgage Payment. The total amount paid each month, which includes principal, interest, property taxes, homeowners insurance, and potentially mortgage insurance. This payment ensures the loan is being repaid while covering associated costs.
Mortgage Insurance. Required for conventional loans when the down payment is less than 20% of the purchase price. Required for FHA loans, protecting the lender if the borrower defaults.
Property Taxes. Local taxes assessed on the property, are often included in the monthly mortgage payment and held in an escrow account by the lender.

Pros and Cons

Pros

Greater buying power. With a lower introductory interest rate, you'll have a lower monthly payment, which could allow you to afford a more expensive home. However, you'll want to make sure you're not stretching your budget too thin. If rates skyrocket after the introductory period, you could be in for a big payment shock.
More time to pay down principal. For the three years you've got that low interest rate, you could use any "extra" money to aggressively pay down your principal. When the ARM resets, or when you decide to refinance, you'll have a smaller mortgage balance. If you stick with the ARM, you're paying interest on a smaller sum. Choose to refi, and your closing costs — which, again, can be 2% to 5% of the loan amount — will be lower, since you're borrowing less.
Flexibility. You might plan on moving in five years or less, and that's a big plus for 3/1 ARMs. If you're not planning on staying in the home long term, you might not have to worry about the ARM's adjustable-rate period. Just be sure you have a plan in place to handle higher payments if rates do rise. You could opt to refinance into a different loan type, or you could sell the home and move on.

Cons

Less predictability. Even knowing the caps and the floor, you don't know exactly what your monthly mortgage payment will be after the introductory period ends. You might have decided during that three years that you absolutely love the house and no longer want to move — and if your budget can't accommodate the rate increases, that could be a problem.
Expensive to leave. If you're planning to move anyway, no big deal. But if you need to refinance to a fixed-rate loan or into a new ARM, you'll have to factor in the cost of refinancing. Refinance closing costs can come to 2% to 5% of the loan costs, which could potentially cancel out the savings from your introductory rate.
Higher introductory rates than 5/1 and 7/1 ARMs. While you'll get a lower introductory rate than a 30-year fixed-rate mortgage, you won't see as big a difference as you would if you got an ARM with a shorter introductory period. A 5/1 ARM will often get you the lowest introductory rate, and a 7/1 ARM can offer an even lower rate if you're willing to wait seven years for a fixed rate. Depending on the lender and on the interest rate climate

How to Get an ARM with a 3-Year Term

Assess Your Financial Health. Obtain a copy of your credit report and check your credit score. Most mortgage lenders require a minimum credit score for approval. Calculate your DTI by dividing your monthly debt payments by your gross monthly income. Lenders typically prefer a DTI of 43% or lower. Aim to save at least 20% of the home's purchase price to avoid private mortgage insurance (PMI), though some lenders offer options with lower down payments.
Determine Your Budget. Use a mortgage calculator to estimate your monthly mortgage payment based on various loan amounts, interest rates, and down payment sizes. Factor in property taxes, homeowners insurance, mortgage insurance, and potential homeowners association (HOA) fees.
Get Pre-Approved. Research mortgage lenders, including banks, credit unions, and mortgage brokers, to find one that offers favorable terms and rates. Provide necessary documentation, such as proof of income, tax returns, and bank statements, to the lender for pre-approval. A pre-approval letter indicates the loan amount you qualify for, which can strengthen your offer when buying a home.
Shop for a Mortgage. Obtain quotes from multiple lenders to compare interest rates, loan terms, and fees. Choose between fixed-rate mortgages, which offer stable payments, and adjustable-rate mortgages (ARMs), which have variable rates that may start lower but can increase over time. The APR includes the interest rate and additional fees, providing a more comprehensive view of the loan's cost.
Choose Your Mortgage. Consider the interest rate, loan term, monthly payment, and any additional costs or fees when choosing the best mortgage offer. Once you’ve chosen a mortgage, you may have the option to lock in the interest rate to protect against rate increases before closing.
Complete the Application. Provide detailed information about your financial situation, employment, and the property you wish to purchase. Some lenders charge fees to process your application.
Go Through the Underwriting Process. Be prepared to submit further documentation as requested by the lender during underwriting. The lender will order an appraisal to ensure the property’s value supports the loan amount. A title company will verify the property’s title to ensure there are no legal issues.
Close on Your Mortgage. This document outlines the final terms of your loan, including the loan amount, interest rate, monthly payments, and closing costs. Review it carefully. Sign the necessary documents to finalize the loan. Bring a cashier's check or arrange a wire transfer for your down payment and closing costs. Once all documents are signed and funds are transferred, you’ll receive the keys to your new home.

Requirements

Credit Score. Lenders typically require a minimum credit score of 620 for conventional loans and 580 for FHA loans. Borrowers with higher credit scores may qualify for lower interest rates and more favorable loan terms.
Debt-to-Income Ratio (DTI). Lenders prefer a DTI ratio of 43% or lower, calculated by dividing the borrower's total monthly debt payments by their gross monthly income. Borrowers with lower DTI ratios are considered less risky.
Income Verification. Borrowers must provide proof of income through pay stubs, W-2 forms, and tax returns. Lenders typically require stable employment and sufficient income to cover mortgage payments.
Documentation. Borrowers must submit various documents, including identification, bank statements, and proof of assets, to verify their financial stability and eligibility for the loan.
Property Appraisal. Lenders require a professional appraisal to assess the property's value and ensure it meets lending standards. The appraisal helps determine the maximum loan amount and protects the lender's investment.

Conditions

Interest Rate. Lenders may offer adjustable-rate mortgages (ARMs) that may start as low as 2.5% for the initial fixed period.
Down Payment. Lenders may require down payments as low as 3% for conventional loans, while borrowers aiming to avoid private mortgage insurance (PMI) may opt for down payments of 20% or more.
Closing Costs. Borrowers should budget for closing costs, which typically range from 2% to 5% of the home's purchase price. Some lenders may offer closing cost assistance or allow borrowers to roll closing costs into the loan.
Loan Amounts. Lenders may offer mortgage loans ranging from $100,000 to $1,000,000 or more, depending on the borrower's financial profile and the property's value.

Ways to Get the Money

Certified Check. Some borrowers may choose to receive mortgage funds in the form of a certified check issued by the lender or closing agent. This method provides a physical form of payment that can be deposited into the borrower's bank account.
Escrow Disbursement. In some cases, mortgage funds are held in an escrow account and disbursed to the appropriate parties at closing. This method ensures that all closing costs and fees are paid before releasing the remaining funds to the borrower.
Direct Deposit. Certain lenders offer the option for mortgage funds to be directly deposited into the borrower's bank account on the day of closing. This electronic transfer provides immediate access to the loan proceeds without the need for physical checks or wire transfers.

Things to Pay Attention To

Interest Rate and APR. Compare both the interest rate and the annual percentage rate (APR) to understand the total cost of the loan, including fees and other charges.
Loan Term. Consider the length of the loan term and how it affects your monthly payments and total interest paid over time.
Type of Mortgage. Determine whether a fixed-rate or adjustable-rate mortgage (ARM) is more suitable for your financial situation and long-term goals.
Down Payment Requirements. Understand the minimum down payment required by the lender and consider how it impacts your upfront costs and monthly payments.
Closing Costs. Review the breakdown of closing costs, including appraisal fees, title insurance, and origination fees, and ensure they align with your budget.
Prepayment Penalties. Check if the mortgage includes penalties for paying off the loan early and consider whether this aligns with your plans for the property.
Private Mortgage Insurance (PMI). Understand if PMI is required for your loan and how it affects your monthly payments, especially if you're making a down payment of less than 20%.

Reasons for Getting Rejected for an ARM with 3-Year Term

Low Credit Score. A history of late payments, defaults, or high levels of debt can lower your credit score, making you a higher risk for lenders. Multiple recent credit inquiries or applications for new credit may signal financial instability to lenders.
High Debt-to-Income Ratio (DTI). Lenders assess your DTI ratio, which compares your monthly debt payments to your gross monthly income. A high DTI ratio may indicate that you are overleveraged and unable to afford additional debt.
Insufficient Income. Lenders require proof of stable income to ensure you can afford mortgage payments. Inconsistent or insufficient income documentation may result in rejection. A short or unstable employment history can raise concerns about your ability to maintain a steady income for mortgage payments.
Inadequate Down Payment. Lenders typically require a minimum down payment, often around 20% of the home's purchase price. A smaller down payment may result in higher risk for the lender and increase the likelihood of rejection.
Poor Property Appraisal. If the appraised value of the property is lower than the purchase price or loan amount, lenders may hesitate to approve the mortgage due to concerns about the property's value as collateral.
Unstable Financial History. Past bankruptcies, foreclosures, or other negative financial events may raise red flags for lenders and result in mortgage rejection. Outstanding collections accounts, tax liens, or other financial judgments can signal financial instability and impact your ability to qualify for a mortgage.

Editorial Opinion

While a 3/1 ARM offers short-term benefits such as lower initial interest rates and monthly payments, borrowers should carefully consider their long-term financial goals and risk tolerance. Opting for an ARM over a fixed-rate loan requires an understanding of potential fluctuations in interest rates and their impact on monthly mortgage payments. Borrowers who prioritize flexibility and anticipate changes in their financial circumstances may find a 3/1 ARM suitable, provided they have a sound exit strategy in place to mitigate potential risks associated with interest rate adjustments.

Important

Keeping your Debt-to-Income (DTI) ratio below 30-40% of your monthly income is crucial. This will help you avoid potential financial problems in the future. Additionally, always assess the necessity and feasibility of taking a loan, ensuring you can comfortably manage its repayment.

How to Choose a Mortage Lender

Check Associations. Look for lenders who are members of reputable organizations, such as the Mortgage Bankers Association (MBA). Membership in these organizations can indicate a higher level of reliability and professionalism.
Review Terms and Conditions. Carefully examine all the terms and conditions of the mortgage contract. Pay special attention to details like the loan term, fixed vs. variable interest rates, and any prepayment penalties.
Interest Rates and Costs. Scrutinize the interest rates and ensure that your contract includes a detailed breakdown of the total cost of the mortgage, including closing costs, origination fees, and any other charges.
Right of Rescission. Remember you can utilize your right of rescission, which typically allows you to cancel the mortgage within three days after signing the agreement. Additionally, use the "cooling-off" period to thoroughly review the contract and make an informed decision before finalizing the mortgage agreement.
Compare Offers. Shop around and compare offers from multiple lenders to find the best rates and terms that suit your financial situation.

Additional resources

To learn more about mortgages and best practices, check out some of the following resources: