A 3/27 adjustable-rate mortgage, also known as a 3/27 ARM, is a 30-year mortgage mostly offered to borrowers who are not ideal. Usually, this means that the borrower has low credit or issues with paying past loans.
3/27 Adjustable Rate Mortgage Details
The 3/27 ARM loans have a fixed interest rate for the first 3 years. These rates are often quite a bit lower than the current rates on a conventional 30-year loan. After the first 3 years, the interest rate goes up, but that will be explained later. These types of loans are meant as a way for borrowers to improve their credit in the first 3 years and refinance during that time.
After the first 3 years, the rates change based on indexes such as the London Interbank Offered Rate (Libor) or the yield on one-year U.S. Treasury bills. The bank where the loan came from will also add some interest on top of the index, this is known as the spread or the fully indexed interest rate. Typically, this rate is much higher than the 3-year fixed interest rate.
Most of the time these loans increase at a rate of 2% per adjustment period. Adjustment periods can be every 6 months or 12 months depending on the loan. Please be aware that the rate can increase by 2 points not 2% of the current interest rate. Sometimes there is a life-of-the-loan cap of 5% or more.
Example of 3/27 Adjustable Rate Mortgage
Jane and John Smith do not have good credit. They want to buy a house but need to improve their credit before getting a conventional mortgage loan. Jane and John decide to get a 3/27 ARM loan. They borrow $250,000 with an initial interest rate of 3.5%.
However, after the first 3 years, Jane and John fail to refinance with a conventional mortgage loan. The floating interest rate is 3% with an additional 2.5% tacked on from the bank. The fully indexed rate is 5.5%. This means that Jane and John’s payments went from $1,123 per month to $1,483 per month. That is a difference of $360.
Pros and Cons of 3/27 Adjustable Rate Mortgage
A huge advantage of the 3/27 ARM loan is that borrowers can get the money they need even though their credit history may not be in the best condition. They also have the first 3 years to improve things and get themselves into a conventional loan.
However, if borrowers are not smart about how they plan finances, repair their credit, and work to get a conventional mortgage loan then the change in interest rates can become an extreme burden. Borrowers often forget how the payments will increase after the first three years and so do not plan accordingly.
Another problem with 3/27 ARM loans is that not all lenders are the most reputable. Borrowers need to be very careful and do their research before signing any paperwork. Borrowers need to make sure the bank they go with has good reviews from previous or current customers. If borrowers go with a bank that doesn't treat their customers well, then they may regret taking out the loan altogether.