A 7/1 ARM is a hybrid mortgage product that combines features of a fixed-rate and adjustable-rate mortgage.
How does a 7/1 ARM work?
A 7-year adjustable-rate mortgage (7/1 ARM) has an interest rate that is "fixed" for the first seven years (84 payments) and then adjusts annually for the next 23 years. The initial rate, known as a teaser rate, is usually lower than prevailing rates for comparable fixed-rate products, like the 30-year fixed-rate mortgage.
A 7/1 ARM may appeal to home buyers that want to purchase a home but need a lower interest rate and monthly payment at the beginning of the loan. Those who will sell or refinance their home soon or expect their income to increase in the near future might benefit from this kind of loan.
7/1 ARM vs. 5/1 ARM
All ARMs offer a fixed interest rate for an initial term, then convert into an adjustable rate. A 7/1 ARM will work the same way as a 5/1: the initial periods will vary (seven years and five years, respectively) and then adjust annually.
As a rule of thumb is that the shorter the fixed-rate period is, the lower the interest rate will be for that period. So your interest rate for a 5/1 ARM would start off lower than a 7/1 ARM.
When deciding between a 7/1 ARM and a 5/1 ARM, think about how soon your circumstances will change. For example:
- If you think you'll move or refinance your home before seven years, you may want to take advantage of the lower rates of a 5/1 ARM.
- If you are waiting on a change in income (perhaps from a career change, promotion, or settlement), then you may want to give yourself extra time with a 7/1 ARM.
7/1 ARM vs. fixed-rate mortgage
A 7/1 mortgage will only have seven years of a fixed interest rate, then the rate will adjust annually for the remaining 23 years of the loan. If you get a 30-year fixed-rate mortgage, then your interest rate (as well as monthly payments) will stay the same for the life of the loan.
Although rates for property taxes, insurance or special assessments could affect your overall monthly payment, it’s generally accepted that fixed mortgage payments are more predictable than payments on ARMs.
Generally, the introductory rate on a 7/1 will come in substantially lower than the rate for a 30-year fixed-rate mortgage. If you need a lower payment than the 30-year fixed rate is offering, then a 7/1 ARM might be better.
If you choose a 7/1 ARM, make sure you have a plan in place should your interest rate increase. As mentioned, common exits for this mortgage include a sale, refinance or the expectation of enough income to cover a higher mortgage.
» SEE: More types of 7/1 mortgages
What's the 7/1 ARM rate?
You can compare 7/1 ARM estimates on sites like Zillow. But your lender will set the actual rate, based on the sum of the margin and an index rate. The rate will be reflected in your loan contract.
Your loan contract details terms such as the:
- Length of your initial term
- Teaser interest rate
- Loan reset date
- How often your interest rate adjusts
- What factors and limitations can affect your interest rate (such as an index or interest rate cap)
How can I calculate a 7/1 ARM mortgage payment?
Different types of 7/1 ARMs
A jumbo loan is a home loan that exceeds the typical lending limits of Freddie Mac, Fannie Mae, the FHA, or the VA. Recently, ARM jumbo loans have had lower interest rates than their 30-year fixed-rate counterparts.
With an interest-only 7/1 ARM, you'll pay just interest for seven years, then have an annually adjustable rate for the remainder of the loan. Lenders that offer interest-only mortgages typically require a higher credit score and a larger down payment, as much as 20%.
On an interest-only loan, you’ll pay only the interest portion of the mortgage (NOT the principal) for an initial period. After the initial term, the loan converts to a traditional (principal PLUS interest) mortgage, but the interest rate is subject to change every year.
The Federal Housing Administration offers two 7/1 ARM options through approved lenders:
- 1% increase annually, and 5% over the life of the mortgage
- 2% increase annually, and 6% over the life of the mortgage
If you have good to excellent credit, you’ll have higher approval odds for an FHA 7/1 ARM. This loan option offers a lower down payment requirement (3.5%) and a lower initial interest rate.
Why should you use a 7/1 ARM?
A 7/1 ARM is best for home buyers who want a lower initial monthly payment and expect their homeownership situation to change within seven years in one of the following ways.
🚗 Moving within 7 years
If you'll sell your home before seven years, you may not want to pay a lot in terms of principal, interest, taxes, and insurance (PITI) for a property you won’t live in for long. An ARM can help preserve cash flow in case you’ll need another down payment for your next home when you decide to move.
💰 Expecting cash influx
When your 7/1 ARM interest rate increases, so will your monthly mortgage payments. More cash on hand means more security. If you're expecting:
- An income increase (e.g., because of a new job or raise), you might be able to cover a higher mortgage payment once your ARM resets
- A windfall (e.g., inheritance or settlement), you could potentially pay your mortgage off before the rate resets
💸 Planning to refinance
Like moving, refinancing means you’ll get out of the loan while you still have the lower initial rate. You may switch to a more predictable, fixed-rate product or any other mortgage product that suits your needs.
7/1 ARM disadvantages
Getting a 7/1 ARM might sound appealing due to the teaser interest rates that tend to be lower than the rates for fixed-rate products. However, your interest rate will be unpredictable after seven years, possibly rising more than you can afford.
A short-term ARM might not be right for you if you expect:
- An economic downturn to prompt the Federal Reserve to raise interest rates
- Your household income to stagnate or decrease
- Your household expenses to increase
This is a mortgage that will have a fixed interest rate for seven years, then the interest rate will adjust annually for the remaining 23 years of the loan.
A 7/1 ARM can be a good idea if you plan to exit the loan, either through a sale or refinance, or anticipate having additional money to pay a higher mortgage note if your interest rate increases.
The 7/1 ARM floating interest rates are based on the margin (outlined in your loan agreement) and an index, which changes daily.
The monthly payments on a 7/1 ARM are based on principal, interest, taxes, and insurance. When the rate resets at seven years, the floating interest rates are based on the margin (outlined in your loan agreement) and an index, which changes daily.