How ARM Rates Work 3-Year, 5-Year, 7-Year, And 10-Year ARMs

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.

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

As mentioned above, a hybrid ARM is a mortgage that starts out with a fixed rate and converts to an adjustable-rate mortgage for the remainder of the loan term. An ARM is an excellent choice if you prioritize lower initial payments and have a clear plan for the future. However, a fixed-rate mortgage is better if you keep the property long-term or are concerned about potential rate increases. As a general rule, the shorter your fixed-rate period is, the lower your interest rate will be.

Pros and cons of a 3/1 ARM

• 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.
• Negative amortization, to put it simply, is when you end up owing more money than you initially borrowed, because your payments haven’t been paying off any principle.
• These loans are generally priced more attractively initially, because there is more potential profit for the lender.
• That means that for 27 years, these homeowners have to deal with fluctuating interest rates that could make their mortgage payments expensive if rates climb.
• The minimum credit score and the maximum debt-to-income ratio that you’re required to have will vary depending on your mortgage lender.
• A 3-year adjustable-rate mortgage functions a lot like any other ARM.

If you chose a 3/1 ARM with 6.63% rate, you’d pay roughly $1,153 per month in mortgage interest and principal. A 30-year fixed-rate mortgage at 5.34% would cost you roughly $1,004 per month. Lenders offer homebuyers who want 3/1 ARMs an initial interest rate for three years.

What are today’s mortgage rates?

When your ARM adjusts to a higher rate, your monthly payment increases. When the loan adjusts to a lower rate, your payment will decrease. An adjustable-rate mortgage starts off with a fixed interest rate for a certain period of time.

Jumbo loans

During periods of higher rates, ARMs can help you save money in the early days of your loan by securing a lower initial rate. Just keep in mind that after the introductory period of the loan, the rate — and your monthly payment — might go up. When shopping for a 3 year mortgage rate, the initial rate should be of less concern than other factors. The margin amount, the caps, the maximum lender fees and the potential for negative amortization and payment shock should all weigh more in your decision than the initial rate.

Should you get an adjustable-rate mortgage?

If you’re buying your forever home, think carefully about whether an ARM is right for you. But at the conclusion of the initial fixed-rate period, ARM rates begin to adjust until the loan is refinanced or paid in full. These rate adjustments follow a set schedule, with most ARM rates adjusting once per year.

Current Mortgage Rates by State

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.

• 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 variable rate is tied to a benchmark, typically the Secured Overnight Financing Rate (SOFR).
• 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.
• A 3-Year ARM mortgage is a type of home loan where the interest rate remains fixed for the initial three years.
• The following table shows the rates for Los Angeles ARM loans which reset after the third year.
• Also referred to as a “teaser rate” or “intro rate,” your start rate is the ARM’s initial interest rate.

Interest rate caps

Just as rate caps are put in place to protect borrowers, rate floors are there to protect lenders. The floor limits the amount your ARM rate can drop if the general rate market is falling and your rate adjusts downward. Also referred to as a “teaser rate” or “intro rate,” your start rate is the ARM’s initial interest rate. This typically lasts 3, 5, 7, or 10 years, with a 5-year fixed intro rate being the most common. ARM start rates are frequently lower than those of a fixed-rate loan. Keep in mind that a 5/1 ARM (and most other ARM loans) still have a total loan term of 30 years.

How ARM rates work: 3/1, 5/1, 7/1 and 10/1 mortgages

Typically, ARM loan rates start lower than their fixed-rate counterparts, then adjust upwards once the introductory period is over. 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. But if rates are falling and your credit score is excellent, refinancing might be worth it to save you money in the long term.

How to Get the Lowest 3/1 ARM Rates

If you still have the ARM loan when the adjustment period begins, your rate could increase. A 5/1 ARM, for example, comes with a five-year initial period during which the rate is fixed. A 3/1 ARM means you have a fixed interest rate for three years, and your interest rate adjusts each year after that. Generally speaking, a shorter fixed-rate period will get you a lower starting interest rate. A 3/6 ARM, for instance, will usually have a lower initial interest rate than a 7/1 ARM, and a 7/1 ARM will have a lower rate than a 10/1 ARM.

Is an adjustable-rate mortgage right for you?

• But three years into the mortgage, the lender might adjust your interest rate — along with your mortgage payment.
• 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.
• Its rate will never increase or decrease, which also means your mortgage payment will never change.
• Only when you’ve determined you can live with all these factors should you be comparing initial rates.
• If your margin is 2 percentage points and the SOFR is 0.15%, then your interest rate would be 2.15%.

Then, it can change in one-year intervals for the rest of the loan term. It’s common for homeowners to refinance into a fixed-rate mortgage before their ARM’s first adjustment. That way, they never have to deal with the risk of expensive rate adjustments and can enjoy stable payments over the life of the loan. If you plan to move and sell your home before your adjustable rate kicks in, a 3-year ARM can save you money with low monthly payments.

Adjustable-rate mortgage FAQ

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. When housing values took a nosedive, many homeowners ended up with underwater mortgages — loan balances higher than the value of their homes. The foreclosure wave that followed prompted the federal government to heavily restrict this type of ARM, and it’s rare to find one today. In order for this to happen, mortgage rates would need to drop, bringing the index used to calculate your ARM’s rate down in tandem. A 5/1 ARM rate gives you an initial rate that’s fixed for five years, and then adjusts every year for the rest of the loan’s term. ARM lenders may require a higher credit score, larger down payment or restrict the amount of equity you can tap.

Rocket Mortgage: Pros and cons

With a hybrid loan the principle is being amortized over the entire life of the loan, including the initial three year period. This is generally the safer type of 3-year ARM for most people, since there is no potential for negative amortization. Generally the rates on these loans are slightly higher than other 3-year loans, since there is less potential profit to the lender. The initial rate, called the initial indexed rate, is a fixed percentage amount above the index the loan is based upon at time of origination. Though you pay that initial indexed rate for the first five years of the life of the loan, the actual indexed rate of the loan can vary.

The initial interest rate on an adjustable-rate mortgage is sometimes called a “teaser” rate, and ARMs themselves are sometimes referred to as “teaser” loans. It’s a good idea to look for mortgage rates have low APRs and zero prepayment penalties for people who want to pay off their mortgage loans early. The annual percentage rate (APR) not only considers how much interest borrowers owe within a year, but it also considers the fees and other charges that they’re responsible for covering.

1 ARM loan FAQ

This is because shorter introductory periods reduce a lender’s risk if rates unexpectedly rise. If you’re not sure whether you can pay for extra interest when the mortgage rate adjusts after three years, you might be better off refinancing and getting another fixed-rate home loan. When it comes to buying a home, cash is king to keep your monthly payments lower. If you can’t afford to put down at least 20%, you’ll have to pay for private mortgage insurance. Plus, you might not get the best interest rate since you’ll need a bigger mortgage and the lender will have more to lose if you default.

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.

With a 3-year adjustable-rate mortgage, you could get in over your head if your rate adjusts too high. Hybrid mortgages, like a 3/1 ARM, provide a variety of benefits, but come also with downsides. The advantage is that borrowers initially have access to mortgage rates that are usually lower than the ones available to people interested in 15-year or 30-year fixed-rate mortgages. However, 3/1 ARMs can be considered risky home loans because homeowners don’t know exactly how their interest rate will change after the initial fixed-rate period ends. When you get a mortgage, you can choose a fixed interest rate or one that changes.

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.

In addition to regular rate resets, these loans typical get recast every 5 years or whenever a maximum negative amortization limit of 110% to 125% of the initial loan amount is reached. Teaser rates on a 3-year mortgage are higher than rates on 1-year ARMs, but they’re generally lower than rates on a 5 or 7-year ARM or a fixed rate mortgage. I’ve covered the housing market, mortgages and real estate for the past 12 years. At Bankrate, my areas of focus include first-time homebuyers and mortgage rate trends, and I’m especially interested in the housing needs of baby boomers. In the past, I’ve reported on market indicators like home sales and supply, as well as the real estate brokerage business. My work has been recognized by the National Association of Real Estate Editors.

On the other hand, if you have a lot of cash on-hand, you can make a big down payment and buy mortgage points. If your interest rate is set at 3.5%, then your monthly P&I payment will remain at $718 until you pay off the loan or refinance. Always read the adjustable-rate loan best 3 year fixed rate mortgage disclosures that come with the ARM program you’re offered to make sure you understand how much and how often your rate could adjust. There are several moving parts to an adjustable-rate mortgage, which make calculating what your ARM rate will be down the road a little tricky.

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.

The FHFA also publishes a Monthly Interest Rate Survey (MIRS) which is used as an index by many lenders to reset interest rates. The mortgage interest deduction is just one tax break that homeowners can qualify for. Some states let homeowners claim a double deduction, meaning that they can claim the mortgage interest deduction when they file both their state and federal income tax returns. Generally, if you want to take advantage of the tax write-off, you’ll have to itemize your deductions.

Homebuyers typically choose ARMs to save money temporarily since the initial rates are usually lower than the rates on current fixed-rate mortgages. A 3-Year ARM mortgage is a type of home loan where the interest rate remains fixed for the initial three years. Following this fixed period, the rate adjusts periodically, typically annually, based on prevailing market conditions and an index specified in the loan terms. These adjustments can lead to fluctuations in monthly mortgage payments, making it crucial for borrowers to comprehend the workings of ARM rates. In analyzing different 3-year mortgages, you might wonder which index is better. In truth, there are no good or bad indexes, and when compared at macro levels, there aren’t huge differences.

Yes, you can refinance your ARM to a fixed-rate loan as long as you qualify for the new mortgage. Yes, you can refinance an ARM just as you can any other mortgage loan. ARM requirements are similar to the minimum mortgage requirements for fixed-rate loans, but with a few significant differences. Especially if you expect interest rates to drop in the next three years, you may want to refinance with a conventional fixed-rate loan.

After 36 months have passed, the homebuyer’s initial rate becomes a fully indexed interest rate that’s equal to a changing index rate plus a margin, which is a fixed percentage. The interest rate on an adjustable-rate mortgage can rise or fall. One of the most common rate cap structures is the 2/2/5 cap structure. You may need a score of 640 for a conventional ARM, compared to 620 for fixed-rate loans.

• When it comes to buying a home, cash is king to keep your monthly payments lower.
• The interest rate on any ARM is tied to an index rate, often the Secured Overnight Financing Rate (SOFR).
• With some I-O mortgages the interest rate is adjusting during the initial I-O period, which gives a potential for negative amortization.
• This protects you as a borrower because it helps ensure you can afford your payments if the rate increases later on.
• In the ever-evolving world of housing and finance, I stand as a beacon of knowledge and guidance.
• After that, the interest rate adjusts on a recurring schedule, typically every six months.
• When compared to other types of mortgages, ARMs typically have stricter requirements.
• The first adjustment is capped at 5%, limiting the increase in the interest rate and reducing the risk of payment shock.
• The 10/1 ARM gives you a low fixed rate for a decade and 20 potential rate adjustments, while a 5/1 ARM only locks your interest rate for five years and has 25 potential rate adjustments.

A fixed-rate mortgage (FRM) has a rate that stays the same over the life of the loan. Its rate will never increase or decrease, which also means your mortgage payment will never change. If you claim the mortgage interest deduction with a 3/1 ARM, don’t be surprised if your tax savings are relatively low, at least for the first three years of your loan term. Because you’ll have a lower interest rate than your neighbors with fixed-rate mortgages, you won’t be paying very much interest in the beginning. Before you apply for an adjustable-rate mortgage, it’s best to compare all of the available mortgage rates. That way you can make sure you’re getting the best deal on your home loan.

• The margin acts as the floor, meaning the interest rate can never be lower than 3%, no matter how much the index rate decreases.
• These introductory low rates entice buyers with lower monthly payments throughout the initial fixed period.
• They may also be defined as a percentage point over the start rate — for instance, five percentage points over your start rate.
• 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.
• Ask the lender which index influences the ARM interest rates and whether the loan comes with rate caps.
• The margin amount, the caps, the maximum lender fees and the potential for negative amortization and payment shock should all weigh more in your decision than the initial rate.

For instance, the APR calculation for a 3/1 ARM assumes that after the first three years, the loan increases to its fully-indexed rate, or rises as high as it’s allowed to under the loan’s terms. It also assumes you’d keep that rate for the remaining 27 years of its term. ARM rates are more complicated than those of fixed-rate mortgages, so shopping for them is a little different also. The 10/1 ARM gives you a low fixed rate for a decade and 20 potential rate adjustments, while a 5/1 ARM only locks your interest rate for five years and has 25 potential rate adjustments. The interest rate on any ARM is tied to an index rate, often the Secured Overnight Financing Rate (SOFR).

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.

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.

Yes, you always have the option to refinance an ARM into a fixed-rate loan — as long as you can qualify based on your credit, income and debt. You can use the savings to pay off your mortgage faster and build home equity. Alternatively, you can use the funds for other financial goals, like saving for college or retirement.