What is a 7/1 adjustable-rate mortgage (ARM)?

Adjustable-rate mortgages (ARMs) tend to have attractive initial interest rates, with introductory rate periods of three, five, seven or 10 years. Here’s what to know about the seven-year version of this mortgage, and whether it makes sense for you.

What is a 7/1 ARM?

A 7/1 adjustable-rate mortgage (ARM) comes with a fixed interest rate for the first seven years. The rate then converts to a variable rate that changes once a year until the mortgage term ends, usually 30 years. The variable rate can adjust up or down, depending on market conditions, within certain limits.

These changes come with risk. Your rate could decrease and trim back some of your monthly mortgage payment, but it could also increase, potentially to an unaffordable level. If you can no longer afford your payments, you could lose your home.

In addition to 7/1 ARMs, some mortgage lenders offer 7/6 ARMs. These are similar in that they have a fixed introductory rate for the first seven years, but the variable rate adjusts every six months after that, rather than once per year.

7/1 ARM requirements

The requirements for a 7/1 ARM vary by lender and loan type. For a conventional ARM, the minimum criteria include:

• 620 credit score
• 5 percent down payment

How does a 7/1 ARM work?

ARM adjustments, including 7/1 ARM adjustments, are based on a benchmark or index rate plus an additional margin set by your mortgage lender. Many ARMs rely on the 11th District Cost of Funds Index (COFI) or the Secured Overnight Financing Rate (SOFR).

ARMs also come with caps that limit how much the rate can increase: the first or initial adjustment cap; a periodic or subsequent adjustment cap; and the lifetime cap. Together with the index and the lender’s margin, these limits help determine your rate.

Example of a 7/1 ARM

Let’s say you take out a 7/1 ARM in the amount of $320,000 at an initial fixed rate of 6.67 percent. The mortgage is indexed against SOFR, and the margin is 1.75 percent. It has a 3 percent first adjustment cap, a 2 percent periodic cap and an 8 percent lifetime cap.

In this scenario, you’ll have a fixed monthly payment of about $2,060 for the first seven years of the mortgage.

Say SOFR has increased by the time your first adjustment hits. Your rate will also increase, but within the parameters of the first adjustment and lifetime caps. With the lifetime cap of 8 percent, your rate can never go higher than 14.67 percent.

Should you get a 7/1 ARM?

While a 7/1 ARM comes with some risk, it could make sense in a few situations. These include:

• You plan to refinance or sell before the first adjustment: Some ARM borrowers plan to refinance out of the ARM or sell the home and pay the ARM off with the proceeds prior to the rate reset. This might work for you, but keep in mind, there’s no guarantee you’ll qualify to refinance or be able to sell your home within the seven-year timeline.
• You expect your income to grow: Some borrowers aren’t as concerned about the risk of an ARM because they expect their earnings to increase substantially by the time of the first rate adjustment. In this case, you might be able to reasonably afford a higher monthly payment –- but, again, there are no guarantees.
• You think interest rates will decline: If rates have been trending lower for some time, you might feel more optimistic they’ll stay that way come the first rate adjustment. Seven years is a long time, however, and there are many factors that could move mortgage rates between now and then. Bottom line: It’s impossible to predict rates, so don’t base your mortgage decision solely on this reasoning.

Pros and cons of a 7/1 ARM

Pros

• It’s cheaper at first. The introductory interest rate on a 7/1 ARM might be much lower than the rate on a 30-year fixed mortgage. A lower rate means lower monthly payments.
• The payments might get even cheaper. If prevailing interest rates are lower at the first rate adjustment or subsequent adjustments, you could save money.
• You’re protected — somewhat. Although there’s a real risk your rate could rise, there are caps that limit the increase.

Cons

• The risk never goes away. With every annual adjustment after those first seven years, your interest rate and payments could increase. This contrasts with a fixed-rate mortgage, which has the same rate and payments for the life of the loan.
• It can be harder to budget for. A mortgage is often a household’s largest monthly expense. Once your rate starts adjusting, it can be more challenging to budget around those payments.
• It has a more complicated structure. An adjustable-rate mortgage has more moving parts than a fixed-rate one, with an index, margin and caps. Some even have interest-only periods. This complexity can make it harder to understand how your rate and payments might change over time.

Other types of adjustable-rate mortgages

7/1 ARMs are just one type of ARM. Some other common options include:

• 10/1 ARM or 10/6 ARM: This has a fixed introductory rate for 10 years. The rate then adjusts annually (10/1) or every six months (10/6) afterward.
• 5/1 ARM or 5/6 ARM: This has a fixed introductory rate for five years. The rate then adjusts annually (5/1) or every six months (5/6) afterward.
• 3/1 ARM or 3/6 ARM: This has a fixed introductory rate for three years. The rate then adjusts annually (3/1) or every six months (3/6) afterward.

7/1 ARM FAQ

• How is an ARM different from a fixed-rate loan?

  The main distinction between an ARM and a fixed-rate mortgage is that the interest rate on a fixed-rate loan remains the same throughout the loan’s term. This consistency means fixed monthly payments. In contrast, an ARM has a fixed interest rate to start, but that rate then changes after the introductory period.

• Can you refinance a seven-year ARM?

  You can refinance a seven-year ARM to another ARM or a fixed-rate mortgage, provided you qualify from a credit and financial standpoint. If you’re eligible, this might be one way to avoid a potential rate increases prior to the first rate reset.

• Can you pay off a 7/1 ARM loan early?

  You can pay off a 7/1 ARM early. However, you might be subject to a prepayment penalty.