What is a 3/27 ARM? (definition)
– A 3/27 adjustable-rate mortgage (ARM) is a 30‑year home loan that has a fixed interest rate for the first 3 years, then a variable (adjustable) rate for the remaining 27 years. It is a hybrid mortgage because it combines an initial fixed-rate period with a later adjustable-rate period.
Key terms (defined)
– ARM (adjustable-rate mortgage): a loan whose interest rate can change after an initial fixed period.
– Index: the market interest-rate benchmark (for example, a one‑year Treasury yield) that the lender uses to set the adjustable rate.
– Margin: a fixed percentage the lender adds to the index to determine the borrower’s new interest rate.
– Fully indexed rate: index + margin — the actual rate that will apply when the loan resets.
– Rate cap: a limit on how much the interest rate can rise at each adjustment and/or over the life of the loan.
– Prepayment penalty: a fee some lenders charge if you pay off or refinance the loan within a specified period.
How a 3/27 ARM works (step-by-step)
1. Origination: You borrow with a 30‑year amortization schedule. The lender quotes an initial fixed annual rate for the first 3 years (often lower than a 30‑year fixed rate).
2. Fixed period (years 0–3): Monthly payments are calculated using the initial rate and scheduled to fully amortize the loan over 30 years if the rate never changed.
3. Adjustment period (year 4 onward): After year 3 the loan converts to an adjustable structure. The lender periodically (commonly every 6 or 12 months) sets a new rate equal to (current index + margin), subject to any caps.
4. Caps: A typical design might cap each adjustment to a maximum increase (for