3/1 ARM Mortgage Rates

3/1 Adjustable-Rate Mortgage Rates

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.

A financial advisor can help you create a financial plan to reach your mortgage goals and needs. Financial advisors can also help with investing and financial plans, including tax, retirement and estate planning, to make sure you are preparing for the future.

Historical 3/1 ARM Rates

3/1 ARM rates have risen over the years. Over the course of 2016, rates averaged to 3.12%. Just three years later in 2019, rates have risen a full percentage point to 4.18%. Since then, Zillow reported that rates for 3/1 ARMs averaged 6.63% at the end of January in 2023.

*Note: These annual average mortgage rates were calculated using daily average mortgage rates reported by Zillow in 2019. No new public data has been reported since then.

Lenders offer homebuyers who want 3/1 ARMs an initial interest rate for three years. 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.

ARMs are often tied to mortgage index rates such as the London Interbank Offered Rate (LIBOR), which is the most common benchmark that banks around the globe use to set short-term interest rates.

How 3/1 ARM Rates Stack Up Against Other Mortgage Rates

The initial mortgage rates associated with 3/1 ARMs are usually lower than those offered for fixed-rate mortgages. But after the 36-month introductory period comes to an end, homeowners with 3/1 ARMs can get stuck with interest rates that are a few percentage points higher than their initial rates.

If you have a fixed-rate mortgage, such as a 30-year fixed-rate home loan, your interest rate and mortgage payment will always remain the same. But if you have a hybrid mortgage loan like a 3/1 ARM, your mortgage payments could drastically change every year once the three-year introductory period is over.

In most cases, folks with 3/1 ARMs have 30-year loan terms. 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.

One way to look at it is if you were buying a home for $225,000 with 20% down. That’s a mortgage loan of $180,000. 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%, which was the average rate for that type of loan in 2022, would cost you roughly $1,004 per month.

Let’s say that after the initial three-year period ends, the rate on your 3/1 ARM increases by 2% to 8.63%. A 2% increase is a common number you’ll see with 3/1 ARMS. With 27 years and roughly $173,564 left on the mortgage, your payments would now be $1,249. 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.

3/1 ARM Rate Caps

Interest rate caps save many homeowners with 3/1 ARMs from having to deal with sky-high rates. These caps limit how much interest rates can increase once interest rates adjust. There are interest rate caps that limit how high interest rates can climb each year as well as ones that prevent interest rates from rising too much over the course of the entire loan term.

Even with an interest rate cap in place, managing your money and sticking to a budget can be difficult when you’re not sure how much your mortgage will cost you. That’s the biggest drawback of having an adjustable-rate mortgage.

3/1 Adjustable-Rate Mortgage Quotes

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.

You can easily find free 3/1 ARM mortgage rate quotes online. Each rate quote will give you an idea of what the mortgage payments for your 3/1 ARM might cost, based on factors like your credit score, your down payment and the price you’re willing to pay for the home you’re buying.

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. Not having a prepayment penalty allows you to pay off your mortgage early if you are ever able.

How to Get the Lowest 3/1 ARM Rates

The lowest 3/1 ARM mortgage rates are typically reserved for the folks with the best financial track records. In other words, these folks have income stability, plenty of cash savings and high credit scores. And they don’t have a ton of debt.

The minimum credit score and the maximum debt-to-income ratio that you’re required to have will vary depending on your mortgage lender. But if your FICO credit score is below 620, you might not be able to qualify for a conventional loan. That means that you might only be able to get a mortgage that’s backed by the FHA (first-time homebuyers) or the USDA (those buying a home in a rural area).

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.

On the other hand, if you have a lot of cash on-hand, you can make a big down payment and buy mortgage points. Both of these actions can reduce your mortgage rate.

Bottom line: If you’re planning to buy a house in the future and you want to save on interest, it’s a good idea to put effort into boosting your credit score, increasing your savings and paying down debt.

Taxes and 3/1 ARMs

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. In addition, those with a mortgage worth more than $750,000 cannot claim the deduction.

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.

If you’re buying a house, keep in mind that you might have to pay a real estate title transfer tax in addition to property taxes. If you decide to sell your home later on, doing so could increase your tax bill.

Refinancing Your 3/1 ARM

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. That means that you’ll have to go through the process of applying for a refinance through your existing mortgage lender (or another lender), hoping for a loan with a lower mortgage rate and then pay for closing costs all over again. But if rates are falling and your credit score is excellent, refinancing might be worth it to save you money in the long term.

Some homeowners will do the opposite. Instead of refinancing from an adjustable-rate mortgage to a fixed-rate, they’ll refinance to an ARM, such as a 3/1 ARM. It might be a good move for short-term lower interest rates if you plan on moving in a few years. But if you’re refinancing and you want to stay in your house for the remainder of your loan term, getting a 3/1 ARM might not make sense. It’s important to run the numbers to see both the costs and the potential savings of either option.

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.