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There are many types of mortgage 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.
Key takeaways
- A 7/1 ARM is a mortgage with an interest rate that can change over time.
- The rate will stay fixed for the first 7 years of the loan, then adjust annually.
- ARMs typically have floor and ceiling rates, as well as a limit on how much the rate can adjust at each adjustment.
- ARMs tend to have lower initial rates than fixed-rate mortgages, but that comes at the cost of potential rises in the loan rate.
What is a 7/1 ARM?
Key terms
There are several varieties of ARMs, dubbed by numbers: X/Y ARMs. The first number represents the number of years in the fixed-rate period. The second number indicates how frequently the rate will adjust thereafter — usually semi-annually or annually.
That means that a 7/1 ARM will keep its initial fixed-rate for seven years (the “7”). After that, the rate will adjust once a year (the “1”). If the rate were to change twice a year, the ARM would be called a 7/6 ARM (the “6” for six months).
How does a 7/1 ARM work?
If you took out a 7/1 adjustable-rate mortgage on July 1, 2023, the first rate adjustment would happen on July 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. For example, the rate might be based on the one-year Treasury bill rate + 3 percent.
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.
For example, you might get an ARM with an initial rate of 6 percent 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. A calculator can help you figure out how your payment could change over time.
- The fixed-rate period. This is the first number in the ARM’s name. The shorter this period, 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. 1, meaning annual changes, is the most common thing you’ll see here.
- Initial cap. This is the limit on how much the rate can adjust immediately after the fixed-rate period ends.
- Periodic rate cap. This is the limit on how much the rate can change at each r 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.
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: You’ll have exposure to higher rates after the fixed period is up. If rates have risen, your payment will increase.
- Complexity: There’s 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.
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. Common offerings 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 so.
- 5/6 ARM. The most popular ARM, these loans have a 5-year rate lock and adjust 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 for the long-term.
- 3/1 ARM. The loans have the shortest rate-lock at three years, with annual adjustments after that. They’re usually popular with people who plan to sell the home within a few years or who are trying to get the lowest-possible payment.
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.
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 look for at least a 5 percent down payment, though 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 will likely increase down the road, possibly stretching your budget in the future.
Is a 7/1 ARM right for me?
7/1 ARMs can make sense in a few situations.
If you’re planning to sell your home within seven years or so, 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 fall. 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 in your budget, think carefully about what you’ll do if rates rise while you have the loan: a refinance is always possible, assuming your home has kept or increased its value, and your financials remain in good shape.
