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.
AAPL
STZ
TSLA
AMZN
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).
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.
When shopping for an ARM, the key details to look at are:
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:
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.
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.
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.