DEFINITION of '3/27 Adjustable-Rate Mortgage - 3/27 ARM'

A type of adjustable-rate mortgage (ARM) frequently offered to subprime borrowers. These 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 with more favorable terms.

3/27 mortgages have a three-year fixed-interest-rate period after which the interest rate begins to float based on an index plus a margin (known as the fully indexed interest rate). There is a high probability that the fully indexed interest rate will be substantially higher than the initial three-year fixed interest rate; therefore, to avoid payment shock, the intent of 3/27 mortgage borrowers is to be able to refinance the mortgage before the interest rate begins to adjust.

BREAKING DOWN '3/27 Adjustable-Rate Mortgage - 3/27 ARM'

A common mistake many 3/27 mortgage borrowers make is a failure to recognize the risks associated with such a mortgage. Many times they do not recognize how much their monthly payments may increase if the interest rate changes. Even if they plan on refinancing before the interest rate starts to move, they fail to foresee future economic conditions that might make refinancing difficult.

For example, the rate of home price appreciation and home equity play a very important role in a borrower's ability to refinance at a future date. Many borrowers are too optimistic about the rate of home price appreciation. Additionally, many 3/27 mortgages carry prepayment penalties, which make refinancing very costly.

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