7-Year Adjustable-Rate Mortgage: Everything You Need to Know

Mortgage interest rates have risen over the past few years, making some buyers reluctant to lock in their home loans at a higher APR. This can make adjustable-rate mortgages appealing due to the potential for lower rates if market conditions change in the coming years. In the case of 7-year ARMs, borrowers can lock in an interest rate for seven years before facing a fluctuating rate.

However, ARMs carry more risk than fixed-rate mortgages — rates could decrease over the next few years but could also rise. This article breaks down everything you need to know about 7-year ARMs, including how they work, pros and cons, and who they’re suitable for.

What is a 7-Year ARM?

The key feature of a 7-year ARM is the fact that it has an adjustable rate. 

Unlike fixed-rate mortgages, ARMs don’t require you to pay the same interest rate throughout your whole loan term. While you will initially sign up for a fixed interest rate over a shorter period, the interest rate will be “reset” at regular intervals. 

While 5-year and 10-year loan terms are more popular options, a 7-year ARM offers an intermediate choice for consumers who want a balance between an accelerated payoff and a more flexible repayment schedule.

The most common type of 7-year ARM is the 7/1 ARM, which resets the interest rate every year after the initial seven years. However, there are also 7/6 ARMs, which reset the interest rate every six months after the first seven years. Other types of 7-year ARMs are rare.

How Does a 7-Year ARM Work?

Often, the initial interest rate you sign up for an ARM will be lower than anything offered by fixed-rate mortgages with longer loan terms, such as 15-year or 30-year fixed-rate mortgages.

After this introductory period ends, the borrowers will generally face higher rates and payments.

Changes in the interest rate of an adjustable-rate mortgage reflect market conditions. The Fed constantly changes its funds rate as part of its monetary policies, which has a knock-on effect on all economic interest rates.

ARMs reflect these changing market conditions using a benchmark or an index, such as the Secured Overnight Financing Rate (SOFR) or the yield on a one-year treasury bill.

Lenders also cap how much a rate can increase at its first adjustment. They will also assess your affordability based on whether you can afford the maximum interest rate cap.

Elements of an ARM

An ARM, therefore, contains the following elements:

• Payment cap: Limit on how much monthly payments can increase.
• Interest rate cap: Limit on how much the interest rate can rise.
• Interest rate: The percentage the borrower pays during the initial fixed-rate period.
• Index rate: Used to base the ARM interest rate on.
• Margin: The difference between the index rate and the ARM rate.
• Adjustment period: How often the interest rate changes after the adjustment period.

Types of 7-Year ARMs

In addition to 7/1 and 7/6 ARMs, you may come across payment option ARMs, which allow you to adapt your payment schedule to your budget (such as opting for minimum payments sometimes and total principal payments).

Interest-only ARMs allow you to pay only interest on your mortgage for a fixed period rather than principal payments.

Then there are government-backed ARMs. In case the borrower defaults, these mortgages provide government backing from government departments, such as the Department of Veteran Affairs (VA) and the Federal Housing Administration (FHA).

Most government-backed mortgages are fixed-rate loans, so government-backed ARMs are niche products. However, they can be a welcome option for making homeownership more accessible to some borrowers. FHA ARMs only require a 3.5% down payment, while VA ARMs are available with 0% down payment. 

7-Year ARM Example

Since a 7/1 ARM is the most common type of 7-year ARM, let’s use this as an example. 

If you buy a house for $300,000 and put down a 10% down payment of $30,000, you will be left with a loan principal of $270,000.

Let’s say a 7/1 ARM loan has an introductory interest rate of 5%. This would mean that for the first 84 months (7 years), the borrower would face monthly payments of $1,449 based on principal and interest payments alone.

According to estimates from US Bank, they would likely also face property taxes and insurance of $583 per month and PMI of $219 per month.

Add this all together, and you have a total initial payment of $1,449 + $583 + $219 = $2,251

Of course, the monthly payment will change after the end of the introductory period. With an interest rate cap of 12% but an expected adjustment of 1%, your maximum payment would be $2,43.77. However, with an interest rate cap of 8%, the maximum payment would go down to $1,869.7.

Pros and Cons of 7-Year ARMs

ARM vs Fixed Rate Mortgages

As mentioned, the initial interest rates on ARMs are generally lower than fixed rates. Plus, the higher interest rates get, the wider the gap between adjustable and fixed rates typically becomes. 

This can result in significant savings on monthly payments, especially throughout the entire mortgage term.

However, it should be noted that the interest rates offered don’t just depend on the loan type. They also vary based on factors such as:

• Location
• Credit score
• Size of down payment
• General market conditions 
• Length of loan term

Is a 7-Year ARM a Good Idea?

A 7-year ARM can be beneficial for borrowers who want to sell or refinance their home after the initial 7-year period. This allows them to get the best of both worlds by securing a lower fixed interest rate for seven years and not having concerns about a higher interest rate and repayments by the end of the period.

Many home buyers exit a mortgage after seven years or less due to moving homes, so they won’t face the higher rates. This is especially true for younger or first-time buyers, who are the most likely groups to upgrade or upsize their homes.

However, a 7-year ARM isn’t a good idea for borrowers who are sure they will stay with the same mortgage lender for more than seven years. In this case, a fixed-rate mortgage for the complete loan term would be the most cost-effective option since the interest rate across the entire mortgage term will generally work out cheaper on average.

Of course, nobody knows whether they will end up staying or leaving their current home or how their financial situation could change. As a result, it’s best to consider various scenarios when taking out a loan. 

Consider a 7-Year ARM If: 

• You’re comfortable with taking some risks. ARMs are inherently more risky than fixed-rate mortgages.
• You have a solid financial profile. This means your income could swallow potentially more significant payments in the future.
• You plan to refinance your mortgage or move home soon. This will allow you to enjoy the introductory period and pull out of the mortgage before a higher interest rate and payments. 

Is Now a Good Time for a 7-Year ARM?

On FreeRateUpdate, you can keep up with average daily mortgage rates for 15-year and 30-year fixed-rate mortgages and compare them with quotes for ARMs. We post the latest rates every day, Monday through Friday.

FAQs

Can I Refinance My 7-Year ARM Before The Fixed Period Ends?

Yes, it’s generally possible to refinance a 7-year ARM at any point in the loan term. Many borrowers choose to do so to lock in another low interest rate. However, you may have to face a prepayment penalty.

Are There Prepayment Penalties On 7-Year ARMs?

Prepayment penalties vary depending on the mortgage lender and the loan terms. Most loans don’t have them — but some do, so it’s always best to check.

Can I Get A 7-Year ARM With A Low Credit Score?

Poor credit history makes it more challenging to secure a mortgage, including 7-year ARMs. However, there are options available, such as government-backed loans.