7/1 ARM Mortgage Rates: Essential Information You Need To Know
Compared to fixed-rate mortgages, adjustable-rate mortgages pose more risk to the borrower because of their unpredictability. However, it can be a more cost-effective alternative, especially if you don’t plan on staying in the same house in the long run. You can also use an ARM as a temporary mortgage while you wait for fixed mortgage rates to decrease.
In this guide, we’ll delve deeper into adjustable-rate mortgages. We’ll explain the basics of ARM loans and their key terminology, cover their strengths and weaknesses, as well as provide insider access to today’s 7/1 ARM interest rates.
What Is An Adjustable-Rate Mortgage?
In contrast to fixed-rate mortgages, an adjustable-rate mortgage (ARM) has floating interest rates, meaning that your monthly principal and interest payments can increase or decrease periodically.
ARM loans feature fixed mortgage rates for a certain period of time at the start of the loan. After this ends, it switches to an adjustable phase where your rates will reset periodically. Generally, the introductory period of an ARM within conforming loan limits features lower rates and payments compared to their fixed-rate counterparts.
The initial introductory period and adjustment frequency of an ARM is stated in the loan’s name. For example, a 7/1 ARM means that you have a fixed interest rate in the first 7 years. After the initial 7-year period has passed, your 7/1 ARM rates will be adjusted every year.
5/1 ARMs where the introductory period lasts five years are the most common type of ARMs. You may also apply for mortgages with shorter introductory periods like a 3/1 ARM or experience a longer period of fixed interest with 10/1 or 7/1 ARMs.
The key difference, in addition to the introductory period length, is the initial fixed interest rate that you’re offered. Shorter introductory periods typically mean lower initial ARM mortgage rates.
Important ARM Terms
ARMs are typically more complicated compared to fixed-rate home loans. To help you understand them better, we’ve compiled several key terms you need to know.
Lenders adjust the interest on your 7/1 ARM based on a certain index. These index movements will influence how much your 7/1 ARM rates are increased or decreased during their annual adjustment periods. Generally, lenders use one of these three major indexes as benchmarks:
The weekly constant maturity yield of one-year Treasury bills.
The 11th District cost of funds index (COFI).
The Secured Overnight Financing Rate (SOFR). This recently replaced the London Interbank Offered Rate (LIBOR) as the adjustment benchmark.
In addition to the index, your rate adjustments are also influenced by a margin. This agreed-upon margin is used in addition to the index movement to calculate your adjustments.
For instance, if the index rate in 2020 is 1.5% and you agreed on a 3 percentage point margin, your interest would be 4.5%. If the index rate drops to 1.25% the next year, the 3% will still be added to it and you’ll have an interest of 4.25% in 2021.
To prevent your 7/1 ARM loan rates from overly steep increases, lenders typically implement caps that limit how much your interest rate can increase. These caps come in three forms:
Periodic rate caps control how much your interest rate can change between years.
Lifetime rate caps put a limit on total interest changes during the loan term.
Monthly payment caps prevent you from being saddled with overly high monthly installments by controlling their dollar value.
Interest Rate vs Annual Percentage Rate: What’s The Difference?
When you’re offered a home loan, lenders usually provide you information on the loan’s annual percentage rate (APR) as well as its interest rate. You should use both to determine the value of a home loan.
While they may seem similar, these have important differences. A loan’s interest rate, typically expressed as a percentage, represents the annual cost of the loan to the borrower. These rates are usually the first thing that you notice on the loan.
However, the APR provides more information compared to the interest rate. Similarly expressed as a percentage, a loan’s APR includes the interest rate alongside other associated fees involved. This means that the APR contains information about any broker fees and closing costs imposed by the lender.
Before submitting your mortgage application, you should always compare the interest rate & APR from several lenders. Two lenders may offer loans with similar interest rates but different APRs – this means that the lender with the higher APR requires you to pay more on other fees.
Keep in mind that APR comparisons are less effective in ARM mortgages because your rates may change without prior notice.
Strengths And Weaknesses Of Adjustable Mortgages
In this section, we’ll break down the main advantages and disadvantages of choosing a 7/1 ARM to finance your home.
Lower Interest Rate
7/1 ARM interest rates are typically lower in their initial fixed-rate period. This initial lower-rate period can help you save money during the first five years of your loan. Thanks to lower interest rates, you can also take out a bigger loan to buy properties with a larger home value.
In addition to lower initial rates, ARM adjustments always follow a certain index. Therefore, you always have a chance of your rates being adjusted to a lower level if index rates fall.
ARMs provide you with some flexibility, especially if you think your plans may change in the next few years. One common way to leverage the low introductory mortgage rates featured in a 7/1 ARM loan is to save up during the first seven years, then refinance or sell your house before the introductory period ends. This allows you to enjoy low-interest rates as well as avoid the unpredictable adjustable phase.
Your Interest Rate May Be Unpredictable
Once your ARM loan enters the adjustable phase after the first 7 years, your interest rate may rise and fall depending on the benchmark index’s performance. Due to this, your monthly mortgage payments may get higher or lower each year.
An ARM is harder to budget for when compared to a fixed mortgage that has consistent payment amounts every year. While lower monthly payment amounts will benefit you, you should always prepare to pay more on your mortgage in case rates rise.
Chance Of Negative Amortization
While mortgage rate caps help control your monthly payments, they can also put you at risk of negative amortization. This happens when the loan’s high-interest rate requires a monthly payment amount that surpasses the cap, causing you to pay less than what you actually owe per month. Because you didn’t pay the required amount on your monthly payments, this causes your loan balance to increase.
Refinancing Your Adjustable Mortgage
Refinancing can be an attractive option if you’re looking to save money on your 7/1 ARM. When you refinance a loan, you’re taking out another mortgage to pay off your current mortgage. Typically, you apply for a refinance to take advantage of a mortgage rate drop.
In a 7/1 ARM, you can avoid the less-predictable adjustment period by refinancing into a fixed-rate mortgage after the first 7 years. By refinancing into a fixed-rate loan, you can protect yourself against fluctuations in your mortgage rate and make your home payments easier to budget.
Conversely, you can also refinance into another ARM if you’re looking to sell your house in the near future. You can experience the lower ARM rate afforded by the initial low-interest period of your new loan while you find a buyer for your house.
However, refinancing usually requires you to qualify for another loan, which means that you need to make sure your credit score and other requirements still qualify you for an affordable mortgage. You should also check the most current refinance rates to find out whether refinancing is worth the effort.
Who Benefits The Most From A 7/1 ARM?
While 7/1 ARMs have their risks, there are several situations where it’s best to apply for a 7/1 ARM instead of a fixed-rate mortgage.
You’re Looking To Sell Your House Soon
The cheaper mortgage payments during the introductory period will allow you to save in the short term. If you don’t plan on staying in the house you bought for the long run, you can take a 7/1 ARM and live in the house for just under seven years. When the introductory period is about to end, you can sell the house and pay off the mortgage before applying for a new one to buy another house.
You’re Expecting An Income Increase
The short-term savings of a 7/1 ARM also makes it beneficial if you need to save up right now but expect to bring in more money in the near future. This is usually chosen by medical or law school graduates, who may require more affordable housing in the short term but are able to pay more expensive monthly payments during the adjustable period – after they land more lucrative jobs.
Alternatives To Adjustable Mortgages
A 7/1 ARM is best if you’re staying in the same house for the short term. If you’re looking for a long-term home financing solution or would like to take advantage of government assistance, you can consider the options below.
Fixed-rate loans feature an interest rate that won’t fluctuate during the entire loan term. Due to this, fixed loans are considered more predictable and much easier to budget for compared to an ARM. Usually, people choose these loans if they want to stay in the home they bought for the long-term. You can also choose this loan type if you prefer predictable payments to make long-term financial planning easier.
However, fixed loans usually have higher rates compared to an ARM’s initial rates, and you can’t change these rates unless you refinance the loan.
If you fulfill certain requirements, a government-backed mortgage can also help you buy homes affordably. Some notable examples of these types of loans are FHA loans, VA loans, and USDA loans. They all have their own qualification criteria as well as their own strengths and weaknesses.
You should keep in mind that while these loans have more lenient credit score requirements, their qualification criteria are usually stricter compared to conventional loans. These loans may also require you to buy mortgage insurance or pay funding fees to secure the loan.
While its unpredictability may come with some risks, a 7/1 ARM can be beneficial if you’re looking for short-term savings. These loans are typically best used if you’re only staying in the house for the short term or expect to earn more money in the near future. However, you should take into consideration the risks of ARMs like unpredictable interest rates or negative amortization.
If you’re considering an ARM to finance your home purchase, Wesley Mortgage, LLC is here to help! Our team of financial professionals can advise you on how to find the best 7/1 ARM that can fit your budget. Contact us today for more information!