3/27 Adjustable-Rate Mortgage (ARM)

A 3/27 adjustable-rate mortgage (ARM) is a 30-year home loan that carries a fixed interest rate for the first three years and a variable rate for the remaining 27 years. It’s a hybrid mortgage often used as a short-term financing tool with the intention to sell or refinance before the adjustable period begins.

Key takeaways

• Fixed-rate period: first 3 years.
• Adjustable period: remaining 27 years, with the rate tied to an index plus a lender margin.
• Initial rates are typically lower than 30-year fixed mortgages, but payments can rise substantially after year three.
• Watch for rate adjustment caps and possible prepayment penalties.

How a 3/27 ARM works

• Initial fixed rate: The lender sets a low fixed interest rate for the first three years.
• Adjustment: After three years the rate resets periodically (often annually or semiannually) based on a benchmark index (for example, a 1-year Treasury yield) plus a lender margin.
• Fully indexed rate: Index + margin = the rate you actually pay once adjustments begin.
• Caps: ARMs commonly include caps that limit how much the rate can increase at each adjustment (frequently around 2 percentage points per adjustment) and over the life of the loan (often around 5 percentage points). These limits vary by lender and loan terms.

Example

Borrower takes a $250,000 3/27 ARM with an initial rate of 3.5%:
* Monthly payment during fixed period (first 3 years): about $1,123.
If, after three years, the index is 3.0% and the lender’s margin is 2.5%, the fully indexed rate becomes 5.5%.
New monthly payment at 5.5% (remaining term): about $1,483 — an increase of roughly $360 per month.

Risks and considerations

• Payment shock: Monthly payments can jump significantly when the rate adjusts. Plan for higher payments or have a refinance/sale strategy.
• Refinancing risk: Refinancing before the adjustable period requires qualifying at that future time. If your credit, income, or home value has worsened, refinancing may be difficult or impossible.
• Prepayment penalties: Some ARMs include penalties for paying off the loan early, which can make refinancing costly. Always check the Truth in Lending disclosure and negotiate terms if needed.
• Market risk: If interest rates rise broadly, adjustable rates and payments will increase accordingly (subject to caps).

Is a 3/27 ARM right for you?

A 3/27 ARM may suit buyers who:
* Expect to sell or refinance within three years.
Need lower initial monthly payments to afford a purchase or free cash for other uses.
Are confident they will qualify to refinance later (stable income, good credit, and home value prospects).

Avoid a 3/27 ARM if you might still own the home past the fixed period and would struggle with potentially higher adjustable payments.

Frequently asked questions

Q: What exactly is a 3/27 ARM?
A: A mortgage with a 3-year fixed interest rate followed by a 27-year adjustable period (total 30-year term).

Q: What are the main advantages?
A: Lower initial interest rate and lower early monthly payments compared with a 30-year fixed mortgage.

Q: What should I check before taking one?
A: Confirm adjustment caps, index and margin used to calculate future rates, any prepayment penalties, and have a realistic plan to refinance or sell before rate adjustments begin.