In recent years, a popular adjustable rate mortgage option has been a 7/6 ARM and has become more widely available. With a 7/6 ARM, you’ll still have a fixed interest rate for the first seven years of the loan. After that term, your rate is readjusted every six months.
These semi-annual rate adjustments are determined along the same factors as a 7/1 ARM. Similar to a 7/1 ARM, the fixed rate period on a 7/6 mortgage typically features a lower interest rate than other fixed rate loans.
Who should consider an ARM?
If adjustable rate mortgage seem like a great fit for your homebuying goals, you might fall into one of the following categories:
Staying for a few years
Buyers who expect to stay in their new home for a short amount of time might benefit from an ARM. By making timely mortgage payments throughout the fixed rate term of the loan, some buyers chose to sell before that period ends, avoiding rate adjustments that could result in a higher monthly bill.
Expect your income to rise
If you expect your income to rise in the next few years, an adjustable rate mortgage may not seem like much of a risk. The extra money coming into your bank account can absorb the additional costs if the index’s average interest rates go up by the end of your fixed rate term.
While you might not want to spend that extra hard-earned income on mortgage interest payments, you won’t be as affected if the economy turns against you. You can never be sure about long-term economic changes, so expecting greater income in the future might provide some additional assurance.
7-year ARM advantages
7-year ARMs offer advantages that you won’t get with other financing structures. Here’s a look at some of the benefits an ARM can provide.
- Lower payments during fixed rate term
- Rate change caps
- Potential for smaller payments
Lower payments during fixed rate term
7/6 ARM rates are typically lower than their fixed rate counterparts, at least for the first seven years of the loan. Even though the rate will adjust eventually, your locked-in rate at the beginning of your amortization schedule will have you paying less each month.
Rate change caps
Your mortgage bill might be higher after your 7/6 ARM rate adjusts, but that arrangement doesn’t come with infinite risk. Adjustable rate mortgages typically come with caps that put a limit on how much your interest rate can increase.
These caps also apply to other adjustable rate mortgages and will help prevent a skyrocketing mortgage bill.
- Initial adjustment cap: The terms in your lending agreement in your lending agreement puts a cap on your rate’s increase or decrease when that initial fixed rate period expires.
- Subsequent adjustment cap: On a 7/6 ARM, interest rates are adjusted twice per year. The subsequent adjustment cap limits how much your rate can increase for each of these semi-annual changes.
- Lifetime adjustment cap: On top of the initial and subsequent caps, ARMs usually include a lifetime adjustment cap to keep the interest rate below a certain point for the full duration of the loan. The height of this cap for your specific ARM depends on your lender, but according to ConsumerFinance.gov, the average lifetime adjustment cap is around 5%. This means the interest rate on an ARM could not exceed 5% of the mortgage’s initial rate.
Potential for smaller payments
The major advantage of an adjustable rate mortgage is that you could save money in the long run. Your initial 7/6 ARM rate will likely be lower than a fixed rate option. If market average mortgage rates continue to dip after the fixed rate period expires, your rate could decrease even further, lowering your monthly mortgage payments. However, this drop depends on the state of the economy and is out of the borrower’s control. We can help you get a solid grasp on market outlooks to find out if a 7-year ARM is your best home loan option.
7-year ARM disadvantages
Like all forms of financing, ARMs come with their own disadvantages. Here are a few key reasons why a 7-year financing plan won’t work for everyone.
- Unpredictability
- Prepayment penalties
- More complexity
Unpredictability
Opting for an adjustable rate mortgage carries a higher degree of risk because of economic unpredictability. After the fixed rate term, your minimum monthly mortgage payments will depend on market factors that are out of your control. If the index continues to go up, so will your monthly interest on an ARM. When your rate is adjusted, you could be paying thousands more in added interest through no fault of your own.
This could make it difficult to predict your available finances down the line. While the rate change caps but a limit on how far your interest will increase, the rate could spike within that range when your 7-year ARM adjusts. When the rate adjusts, you might have to alter some of your savings or investment goals. This can make ARMs a more volatile lending option than fixed rate mortgages, which guarantee an established interest rate for the full term of the loan.
Prepayment penalties
If you’re planning to sell or refinance within the first few years, you might be obligated to pay a prepayment penalty to your lender. This fee is not required by all lenders, so if you do plan on staying in the home for only a number of years, be sure to choose a financing plan that does not come with this stipulation.
More complexity
With changing interest rates, market unpredictability and additional stipulations, some borrowers might view adjustable rate mortgages as a complicated lending option.
These mortgages do come with more rules than their fixed rate counterparts, but the right real estate agent and lending partner can cut through the confusion and help you decide if an ARM is your best financing option.
The math on a 7/6 ARM loan
For a better understanding of how you can potentially save with an adjustable rate mortgage, let’s crunch some numbers.
Two buyers are approved for a $200,000 home loan, with one opting for a 30-year fixed rate mortgage and the other choosing a 7/6 ARM. In this scenario, let’s assume the 7/6 ARM interest rate was 2.375% and the 30-year fixed is 3.125%.
Take a look at how much each buyer could possibly pay throughout the first seven years of their loan:
First 7 years of an 7/6 ARM
- Loan amount: $200,000
- 7-year ARM monthly payment: $1,266.21
- Total after 7 years: $106,361
First 7 years of a 30-year fixed rate mortgage
- Loan amount: $200,000
- 30-year fixed monthly payment: $1,342.48
- Total after 7 years: $112,768.32
Clearly, the 7/6 ARM borrower will have a lot more money left over after 7 years. However, it’s important to remember that when the rate adjusts, you could end up paying more in interest than you were previously. With a 30-year loan, however, you’ll have built up more equity in the home when the first seven years are up.