What is a 3/27 adjustable rate mortgage?
A 3/27 adjustable rate mortgage, or ARM 3/27, is a 30-year mortgage frequently offered to subprime borrowers, which means people with lower credit scores or a history of default. Mortgages are designed as short-term financing vehicles that give borrowers time to repair their credit until they are able to refinance into a mortgage on more favorable terms.
Understanding variable rate mortgages 3/27 (ARM 3/27)
Variable rate mortgages 3/27, or ARM 3/27, have a fixed interest rate period of three years, which is generally lower than the current rates of a conventional 30-year mortgage. But after three years and for the remaining 27 years of the loan, the rate floats based on an index, like the London Interbank Offered Rate (Libor) or the yield on one-year US Treasury bills. The bank also adds a margin above the index; the total is called the fully indexed spread or interest rate. This rate is generally much higher than the initial three-year fixed interest rate, although 3/27 mortgages generally have an upward ceiling. Generally, these loans reach a markup rate of 2% per adjustment period, which can take place every six or 12 months. Note that this means that rate can increase by two full points, not 2% of the current interest rate. There may also be a lifetime limit of 5% or more. To avoid a payment shock when the interest rate starts to adjust, 3/27 mortgage buyers generally intend to refinance the mortgage during the first three years.
An excellent price, but a risky offer
A serious risk for borrowers is that they cannot afford to refinance their loan in three years. This could be due to a credit rating that is still below normal, or a decline in the value of their home, or simply due to market forces that cause a general rise in interest rates. In addition, many 3/27 mortgages have prepayment penalties, which makes refinancing expensive.
Many 3/27 mortgage borrowers fail to recognize how much their monthly payments increase after three years. For example, suppose a borrower takes out a loan of $ 250,000 at an initial teaser rate of 3.5%. It’s an excellent mortgage rate to start with, but suppose after three years the LIBOR is 3% and the bank’s margin 2.5%. This represents a fully indexed rate of 5.5%, which corresponds to the annual ceiling of 2 points on the loan. Overnight, the monthly payment goes from $ 1,123 to $ 1,483, a difference of $ 360. That’s a lot of grocery money. Because payments can increase significantly, borrowers must plan carefully before taking out a mortgage 3/27.