7/1 ARM: Definition And Today’s Rates
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If you're searching for a home but don't expect to be in it very long, you may end up paying more than you need to if you decide to go with a 30-year fixed mortgage. It's possible to lower your monthly payment if you choose to go with an adjustable-rate mortgage, such as a 7/1 ARM.
Often, consumers dismiss this mortgage option before understanding how it works. For some first-time home buyers or refinancers, a 7/1 ARM could be a good option for saving money since it tends to offer low rates along with 7 years of fixed payments, 2 years more than the popular 5/1 ARM.
Rocket Mortgage® doesn't offer 7/1 ARMs at this time. Instead we offer 7/6 ARMs. The only difference is that these adjust every 6 months as opposed to once per year.
So, if you're in the market for a new home, here's why a 7/1 or 7/6 ARM might be worth considering.
What Is A 7/1 ARM?
A 7/1 ARM is an adjustable-rate loan that carries a fixed interest rate for the first 7 years of the loan term, along with fixed principal and interest payments. After that initial period of the loan, the interest rate will change depending on several factors.
7/1 ARM Loan Basics
There are several basic components of a 7/1 ARM that borrowers need to be aware of when assessing their loan options.
Since the initial interest rate is only fixed for 7 years, the future rates and payments can vary dramatically after the rate adjustment, depending on the ARM and the current market. Even if rates are stable, your monthly payments may change significantly throughout the loan term.
Several factors impact 7/1 ARM rates, including the index it's attached to, the margin, interest rate caps, payment caps and intervals.
In general, the interest rate and monthly payment of an ARM can change every month, quarter, year, 3 years or 5 years. The duration between the change in rate is called the adjustment period or interval.
For a 7/1 ARM, the introductory period is 7 years, and then once that expires, the interest rate can adjust once annually. Keep in mind, not all ARM loans may adjust downward. That’s why you should make sure to read the fine print of the loan agreement before moving forward.
Lenders may base ARM rates on various financial market indexes. Some of the most common indexes used for ARMs areTreasury (CMT) securities, the Cost of Funds Index (COFI), and the London Interbank Offered Rate (LIBOR).
To determine an interest rate on an ARM, a slight amount is added to the index rate to cover the cost of lending the money. This addition is known as the margin.
Usually, lenders determine a borrower’s margin by assessing their credit score. Essentially, the better your credit score, the lower the margin you’ll qualify for. When considering an ARM, make sure to review the index and margin.
Interest Rate, Lifetime and Payment Caps
Interest rate caps put a limit on how much the interest rate can increase. These caps come in two versions: periodic adjustment caps and lifetime caps. With a periodic adjustment cap, a limit is placed on the amount a rate can increase or decrease during each adjustment period. Also, there is a limit placed on the amount a rate can increase throughout the loan term with a lifetime cap. Most ARM loans must have a lifetime limit by law.
Additionally, there are caps on payment amounts, which limit the amount the monthly payment can increase or decrease over thelife of the loan. Make sure you know all of your interest and payment caps when considering an ARM.
7-Year ARM FAQs
Of course, a 7/1 ARM comes with some advantages and disadvantages. To better understand if a 7/1 ARM is right for you, here are some common questions you should consider.
What are the advantages of a 7/1 ARM?
There are several reasons to choose a 7/1 ARM, which include:
- Lower payments during the fixed-rate period: Any ARM loan offers potential savings during the initial fixed-rate period compared to a standard fixed-rate loan. With a 7/1 ARM, your introductory period is locked in for 7 years before any adjustments are made. This period gives you 7 years of predictable payments at a low interest rate.
- Flexibility: If you think your life may change in the next few years, an ARM loan can be a great idea and a way to save money.
- Payment and rate caps: 7/1 ARM loans can have several caps, limiting the size of your payment and rate increases and decreases. Caps can include the amount the rate can adjust between periods as well as the maximum interest rate change.
What are the disadvantages of a 7/1 ARM?
While there are advantages to a 7/1 ARM, some downsides are worth taking a look at. The disadvantages include:
- Unpredictability: With ARM loans, borrowers must prepare for rates and their mortgage payments to change after the fixed interest period expires. Even for borrowers who carefully plan, mortgage payment changes can be a shock. Therefore, this leaves homeowners vulnerable to financial stress if interest rates increase.
- Payment penalty: Some lenders may charge a penalty if you decide to sell or refinance your home loan within a specific timeframe. Therefore, if you plan to sell within a certain amount of time, make sure your lender will not charge you a penalty. Rocket Mortgage never changes pre-payment penalties.
- Complexity: ARMs are complex. They come with complicated rules, fees, and payment structures at times. If a borrower struggles to understand how their ARM works, it could pose a risk to the borrower.
- Shorter fixed-rate period: While 7 years might seem like a long amount of time, some borrowers may appreciate a bigger fixed-rate period. 10/1 ARMs can give home buyers an extra 3 years of steady monthly payments that a 7/1 ARM can’t offer.
The Bottom Line: Should You Get A 7/1 ARM?
If you’re confident that you can make your monthly payments even if the interest rate reaches the maximum amount, then a 7/1 ARM is worth considering. A 7/1 ARM loan might also be worth the risk if you think you’re only going to be in your home for a short period of time before you sell again. This way, you can capitalize on the lower monthly payments.
On the other hand, if you either feel more comfortable with predictable payments or plan to be in your home for a substantial amount of time, a fixed-rate mortgage might be more up your alley. If you’re unsure of what to do, talk to a Home Loan Expert at Rocket Mortgage®, who can help you determine the best options for your unique situation. Speaking with an expert can ensure you’re making the best decision suitable for your needs.