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- A 7/1 ARM is a type of mortgage loan that starts with a fixed interest rate for the first seven years, then adjusts annually thereafter.
- The initial fixed-rate period for a 7/1 ARM can have a lower interest rate compared to a traditional fixed-rate mortgage, making it appealing to those looking for smaller monthly payments.
- 7/1 ARMs can be a good option for those planning to sell their home or refinance within the first seven years, but may not be suitable for those planning to stay in their home for the long term or who are not prepared for potential rate increases.
There are many types of mortgages out there, but they tend to fall into two broad categories, fixed-rate mortgages and adjustable-rate mortgages (ARMs). 7/1 ARMs are a type of adjustable-rate mortgage — one of the most popular, in fact. They may be a good fit for borrowers who plan to stay in their home for only a few more years, or who expect interest rates to fall over time.
What is a 7/1 ARM?
A 7/1 adjustable-rate mortgage (ARM) is a type of mortgage that starts with a fixed interest rate for the first seven years and then adjusts annually thereafter. This home loan combines features from both fixed-rate and adjustable-rate mortgages. Its primary allure lies in its lower starting interest rate compared to fixed-rate mortgages, which can lead to lower initial monthly payments.
However, once the fixed-rate period ends, the interest rate can fluctuate — either up or down — depending on market conditions. This flexibility can be a double-edged sword: while falling rates could lead to lower payments, rising rates may increase your payments. The potential for such changes can make a 7/1 ARM an appealing option for those intending to sell their home or refinance to a fixed-rate mortgage within the first seven years.
How does a 7/1 ARM work?
If you took out a 7/1 adjustable-rate mortgage on November 1, 2023, the first rate adjustment would happen on November 1, 2030 — that is, seven years after you closed on the loan.
When the interest rate of an ARM adjusts, it will be set to a new rate, typically based on a benchmark or index, plus an additional few percentage points (called a margin). Your loan documents will tell you what index and margin are used.
Other commonly used indexes for ARMs are the 11th District cost of funds index (COFI) and the Secured Overnight Financing Rate (SOFR).
Usually, the loan document will also outline a minimum and maximum rate, as well as a limit on how much the rate can adjust at one time. This helps reduce the shock when interest rates reset for the first time after the initial seven-year fixed-rate period.
For example, you might get an ARM with an initial rate of 6 percent, a minimum rate of 5 percent, a maximum rate of 12 percent, and a maximum change of 2 percent per adjustment. When the first adjustment period comes, if rates have gone up, the loan rate might increase to 7.5 percent. A year later, it could rise again by as much as 2 percent, or fall by as much as 2 percent.
The rate will continue to change annually until you pay off the loan.
Remember, each monthly payment you make covers all interest that accrued since your last payment, plus some principal. That means that an increase in the loan’s interest rate will lead to an increase in your monthly loan payment. An ARM calculator can help you figure out how your payment could change over time.
What are the pros and cons of a 7/1 adjustable-rate mortgage?
Pros of a 7/1 ARM
- Cheaper at first: Interest rates for a 7/1 ARM can be a full percentage point below a 30-year fixed mortgage. That means lower monthly payments.
- The payments might get even cheaper: If interest rates are falling, then your monthly payment will also decline after the initial period and potentially during future resets.
Cons of a 7/1 ARM
- Rising rates could cost you more: Long-term interest rates are hard to predict. You might face higher or lower interest rates once your fixed introductory period expires. If rates have risen, your payment will increase.
- Complexity: There are more moving parts to an adjustable mortgage than a fixed one. Rate caps, indexes, resets — this can be pretty technical stuff for the average homeowner.
- Interest-only trap: With some ARMs, known as “interest-only” ARMs, your initial payments go toward only the loan interest and not principal in the initial fixed-rate period. That can allow you to stretch your budget and lower your payment, but after the fixed period your payments will be much higher to include the principal. If home values drop, you could find yourself underwater on the loan.
7/1 ARM qualifications
ARMs, like any mortgage, have strict underwriting requirements. You’re committing to a long-term loan for a large amount and the lender wants to make sure you’ll repay the loan.
Most lenders like to see applicants with at least a “fair” credit score, meaning 620. They’ll also look at your debt-to-income (DTI) ratio and the size of the down payment you’re offering. Most lenders will require at least a 3 percent down payment. (Bear in mind that you’ll incur private mortgage insurance premiums (PMI) if you’re paying less than 20 percent.)
In some cases, ARMs can be easier to qualify for than other loans. Their lower initial rates mean smaller payments, which can keep your debt-to-income ratio lower than with a fixed-rate loan that has a higher rate. Just remember that your mortgage rate might increase down the road, possibly stretching your budget in the future. However, some lenders will consider a borrower’s capacity to handle interest rate increases when assessing them for a loan.
Current 7/1 ARM rates
Interest rates for 7/1 ARM loans, as well as for all mortgage types, constantly change. The average 7/1 ARM interest rate was 7.19 percent on Nov. 20, 2023, according to Bankrate’s survey of national lenders. To compare, the national average interest rate for 30-year fixed-rate mortgages was 7.74 percent for the same day. To get the most current interest rates and annual percentage rates (APRs) available for this loan type, check out Bankrate’s 7/1 ARM rates. Keep in mind that these rates and APRs are based on a 740 FICO credit score and an owner-occupied single-family home.
Other types of adjustable-rate mortgages
7/1 ARMs are just one type of ARM. Lenders offer many other adjustable-rate mortgages with different rate lock and rate adjustment periods. Other common options include:
- 10/1 ARM – These loans have a 10-year rate lock and adjust annually after that. They can be good for people who plan to stay in the home for a decade or more.
- 5/6 ARM – A 5 ⁄ 6 ARM loan has a 5-year rate lock and adjusts semi-annually after that. They’re better for people who think rates are going to fall or who don’t plan to stay in the home long term.
- 3/1 ARM – The loans have the shortest rate-lock period at three years, with annual adjustments after that. They’re usually popular with people who plan to sell their homes within a few years or who are trying to get the lowest possible payment. They’re also a popular option among people who expect interest rates to drop within three years and are planning to refinance.
These are just a few examples of popular ARMs. Lenders are largely free to offer different terms, such as 15-year rate lock periods or letting borrowers select their own payment structure and schedule.
How to compare ARMs
When shopping for an ARM, the key details to look at include:
- The fixed-rate period: This is the first number in the ARM’s name. The shorter this period is, the lower the initial rate will typically be. However, the variable-rate period will be longer, exposing yourself to more risk if rates rise. Typical fixed-rate periods are three years, five years and seven years.
- Teaser rate: The initial interest rate offered in the fixed-rate period.
- Adjustment intervals: This is the second number in the ARM’s name. It’s the frequency with which the rate will change after the fixed-rate period ends. The number “1,” meaning annual changes, is the most common number you’ll see here.
- Initial cap: This is the limit on how much the rate can adjust immediately after the fixed-rate period ends, expressed in percentage points.
- Periodic rate cap: This is the limit on how much the rate can change at each adjustment date. It may be the same or different from the initial cap.
- Lifetime cap: This limits how much the interest rate can rise over the term of the loan.
- Payment cap: This limits the dollar amount the monthly payment can rise over the life of the loan.
- Minimum and maximum rate: These are the lowest and highest rates that your loan’s rate can adjust to.
- Minimum and maximum monthly payment: These values will help you understand if you can afford changes in your monthly payment due to the interest rate adjusting.
Is a 7/1 ARM right for me?
A 7/1 ARM can make sense in a few situations. If you’re planning to sell your home within seven years, a 7/1 ARM can be a great fit. You’ll benefit from the lower interest rate without having to worry about the rate rising with each adjustment.
It might also be a good choice if you expect interest rates to decline over the next several years. If rates are lower than when you got your loan when the adjustment date comes, your loan rate could decrease rather than rise, meaning you’ll save money.
If you do plan to stay in the home for the long term, make sure to be prepared for potential rate increases. Think about what the maximum loan rate is and how that will affect your payment. If you can’t fit that payment into your budget, a fixed-rate mortgage might be a better option because it offers more predictable, stable payments over the loan’s term.
Frequently asked questions about 7/1 ARMs
7/1 ARMs typically offer a lower initial interest rate for the first seven years as compared to fixed-rate mortgages. This can result in lower monthly payments at the beginning, which can be beneficial if you plan to move, refinance or earn a higher salary before the rate adjustment period begins. However, once the initial fixed-rate period is over, your interest rate and monthly payments can increase if market rates rise.
The main distinction between an adjustable-rate mortgage and a fixed-rate loan lies in the interest rate structure. A fixed-rate loan locks in the interest rate at the time the loan is secured, and this rate remains constant throughout the loan term. This consistency allows for predictable monthly payments.
In contrast, an ARM typically starts with a lower interest rate than fixed-rate mortgages, but after a specified introductory period, the rate can go up or down. While ARMs often include caps that limit the maximum and minimum levels the interest rate can adjust, the potential for variable payments makes ARMs inherently more risky than fixed-rate loans.