If you're looking for a home but don't expect to live in it for very long, consider an adjustable-rate mortgage. You can end up paying more than you need to if you decide to go with a 30-year fixed-rate mortgage. It's possible to lower your monthly payment if you go with an adjustable-rate mortgage, like a 3/1 ARM.
Many borrowers dismiss this mortgage choice before understanding how it works. For some first-time home buyers or refinancers, a 3/1 ARM can be a good choice for saving money. They often offer lower interest rates along with 3 years of fixed payments. Also, if you move out within the first 3 years, you won't have to worry about a rate adjustment.
So, if you're looking for a new home, here's why a 3/1 ARM can be worth considering.
What is a 3/1 Adjustable-Rate Mortgage (ARM)?
An adjustable-rate mortgage (ARM) typically offers a lower interest rate for a set amount of time. After the fixed period ends, the mortgage rate can adjust based on the current market situation.
A 3/1 ARM is an ARM that has a fixed interest rate for the first 3 years of the loan. That means for the first three years, the principal and interest payments stay the same. After that three-year period of the loan, the interest rate will change depending on several factors.
3/1 ARM Loan Basics
There are several basic factors of a 3/1 ARM that borrowers need to be aware of when deciding on one.
Rates
Since the starting interest rate is only fixed for 3 years, the future rates and payments can vary. There can be significant rate changes, depending on the ARM and the current market. Even if rates are stable, your monthly payments can change significantly throughout the loan term.
Adjustment Interval
In general, the interest rate and monthly payment of an ARM change periodically. They can change every month, quarter, year, 3 years, or 5 years. The duration between the change in rate is called the adjustment period or interval.
For a 3/1 ARM:
- Initial period: 3 years of fixed rate
- Adjustment frequency: Once per year after the initial period
The Index
Lenders base ARM rates on different financial market indexes. Some of the most common indexes used for ARMs include:
- SOFR (Secured Overnight Financing Rate) - Most commonly used
- CMT (Treasury securities)
- COFI (Cost of Funds Index)
The index rate serves as the baseline for your adjusted interest rate calculations.
The Margin
To figure out an interest rate on an ARM, a base percentage is added to the index rate. This addition is done to cover the cost of lending the money. This addition is known as the margin.
Key points about margins:
- Lenders can decide on a borrower's margin based on a flat percentage or credit score
- Better credit scores typically qualify for lower margins
- Your rate will never be lower than the margin
- When considering an ARM, carefully review both the index and margin
Interest Rate Caps And Floors
Interest rate caps put a limit on how much the interest rate can increase. Usually, these come with corresponding floors that limit how much your payment can move downward as well. These caps and floors come in three versions:
- Initial adjustment cap: Limits change at the first adjustment
- Periodic adjustment cap: Limits change with each subsequent adjustment
- Lifetime cap: Limits total change throughout the loan (required by law on most ARMs)
Advantages of a 3/1 ARM
Lower Payments During the Fixed-Rate Period
Any ARM loan offers potential savings during the starting fixed-rate period compared to a standard fixed-rate loan. With a 3/1 ARM, your introductory period is locked in for 3 years before any adjustments are made. This period gives you 3 years of predictable payments at a low interest rate.
Flexibility for Short-Term Homeowners
If you're planning to:
- Sell your home within 3 years
- Relocate for work
- Upgrade to a larger home as your family grows
- Refinance when your financial situation improves
A 3/1 ARM allows you to take advantage of lower rates without worrying about adjustments.
Interest Rate Caps Provide Protection
While rates can adjust after the initial period, caps protect you from extreme payment increases. This provides some predictability even during the adjustment period.
Disadvantages of a 3/1 ARM
Unpredictability
With ARM loans, borrowers must be prepared for rates and mortgage payments to change anytime after the fixed interest period expires. Even for borrowers who carefully plan, mortgage payment changes can be a shock. This can leave homeowners vulnerable to financial stress if interest rates increase significantly.
Complexity
ARMs are complex instruments with:
- Complicated rules and fee structures
- Various payment structures
- Multiple factors affecting rate adjustments
If a borrower struggles to understand how their ARM works, it can pose a financial risk.
Very Short Fixed-Rate Period
While 3 years can seem like a long time, it passes quickly. Some borrowers may appreciate a longer fixed-rate period for more stability. Consider whether 3 years provides enough time for your plans.
Limits on Interest Rate Decreases
Your interest rate can't go up beyond the cap, but there are also corresponding floors limiting how much your rate can decrease. Additionally, your rate will never go below the margin set by your lender, even if the index drops to zero.
Who Should Consider a 3/1 ARM?
A 3/1 ARM might be right for you if:
You're a Short-Term Homeowner
- Planning to move within 3 years
- Expecting a job relocation
- Buying a starter home before upgrading
Your Income Will Increase
- Starting a new career with growth potential
- Expecting significant raises or bonuses
- Building a business that will generate more income
You Can Handle Rate Adjustments
- Have sufficient emergency savings
- Can afford payments even at the rate cap
- Have flexibility in your budget
You Want to Maximize Savings
- Need lower initial payments for other investments
- Want to pay down principal faster with savings
- Plan to refinance before adjustments begin
Who Should Avoid a 3/1 ARM?
A 3/1 ARM might not be suitable if:
You Need Payment Stability
- Living on a fixed income
- Have tight monthly budgets
- Cannot handle payment increases
You're Buying Your Forever Home
- Plan to stay longer than 3 years
- Want predictable long-term payments
- Value peace of mind over potential savings
You're Risk-Averse
- Uncomfortable with uncertainty
- Worry about rate increases
- Prefer simple, straightforward mortgages like conventional loans
Making the Decision: Key Considerations
Calculate Your Break-Even Point
Compare the savings from a 3/1 ARM versus a fixed-rate mortgage:
- Calculate monthly savings during the fixed period
- Estimate potential payments after adjustment
- Determine total savings if you sell/refinance within 3 years
Understand the Worst-Case Scenario
Before choosing a 3/1 ARM:
- Calculate maximum possible payment with caps
- Ensure you can afford this payment
- Have a backup plan if rates increase significantly
Review Your Timeline
Be realistic about your plans:
- How certain are you about moving?
- What could change your timeline?
- Do you have flexibility if plans change?
The Bottom Line: Should You Get A 3/1 ARM?
A 3/1 ARM loan can be worth it if you're only going to own your home for a short period. This way, you can capitalize on the lower monthly payments and save potentially thousands of dollars over the first three years.
The key is being honest about:
- Your timeline for homeownership
- Your ability to handle payment changes
- Your comfort with calculated risk
If you can make your monthly payments even if rates hit the highest allowed cap, and you're confident about your short-term plans, a 3/1 ARM is worth serious consideration.
Next Steps with SRK CAPITAL
Ready to explore whether a 3/1 ARM is right for your situation? At SRK CAPITAL, our ARM specialists can:
- Compare 3/1 ARM rates with other loan options
- Calculate your potential savings
- Explain all terms and conditions clearly
- Model different rate scenarios for your budget
- Guide you through the entire loan process
Don't dismiss ARMs without understanding their potential benefits. For the right borrower in the right situation, a 3/1 ARM can be a powerful tool for homeownership and financial flexibility.
Contact SRK CAPITAL today to start your loan approval and discover if a 3/1 ARM aligns with your homeownership goals and financial strategy. You can also explore our other types of mortgages including VA loans, FHA loans, and jumbo loans to find the perfect fit for your needs.