7/1 ARM: Your Guide to 7-Year Adjustable-Rate Mortgages

An adjustable-rate mortgage (ARM) has an interest rate that can change at intervals during your loan term. Unlike a fixed-rate loan, which has the same interest rate for the entire loan term, a hybrid ARM has a rate that can vary from year to year. With a 7/1 ARM, you get a fixed rate for the first seven years, followed by an adjustment period where your rate can change.

Here’s how a 7/1 ARM works, the pros and cons, and when an adjustable-rate mortgage makes the most sense.

What is a 7/1 ARM loan?

A 7/1 ARM is a type of hybrid adjustable-rate mortgage that has a fixed-rate period followed by an adjustment period. The two numbers at the beginning indicate the timeline for each period: 

1. The first number: The number of years in which your interest rate remains fixed.
2. The second number: How often the rate will adjust annually after that fixed period.

If you had a 7/1 ARM with a 30-year term, you’d have a fixed mortgage interest rate for the first seven years. After that, your interest rate and payment adjust once a year for the remaining 23 years. 

Learn More: What Is a Mortgage Rate and How Do They Work?

How a 7/1 ARM works

A 7/1 ARM gives you a fixed rate for the first seven years of your loan. During this time, your monthly payments will be more predictable as you pay off principal and interest. After the fixed-rate period ends, the adjustment period begins. Your lender will evaluate market conditions annually and determine whether to adjust the interest rate higher or lower. Your monthly payments will rise or fall accordingly to ensure your mortgage is paid off on time. 

Here’s a closer look at how 7/1 ARMs work:

Changing rates

Adjustable rates are determined by an index, which represents a market rate, and the margin that’s added to the market rate. Each year after your fixed-rate period, the lender will review market rates, add the margin to the index, and adjust your payment.

Here’s a quick breakdown of how the index and margin make up your rate:

• Index: Current market conditions are usually expressed using an index. Many U.S. lenders use the Secured Overnight Financing Rate (SOFR), Constant Maturity Treasuries (CMT), or the Cost of Funds Index (COFI).
• Margin: Your lender adds a fixed percentage on top of the index rate to get your new interest rate. For example, if you have a margin of 6.5 percentage points and your rate adjusts based on the SOFR — and the SOFR is at 0.15% — your new mortgage rate would be 6.65%.

Read More: 10/1 ARM: Your Guide to 10-Year Adjustable-Rate Mortgages

Interest rate caps

Even though your mortgage rate adjusts regularly with a 7/1 ARM, following the initial fixed period, there are caps on how much the rate can change.

It’s common for caps to be based on an initial adjustment, subsequent adjustments, and a lifetime cap. One common structure is the 2/2/5 cap. Here’s how this cap structure works:

• Initial adjustment cap: The first number indicates the initial adjustment cap. This is the first time the lender adjusts the rate after the end of the fixed term. In the case of the 2/2/5 cap, the rate can’t be more than 2 percentage points higher than your initial rate, no matter how much interest rates have increased since you got your loan.
• Subsequent adjustment cap: The second number represents the cap on the following adjustments. In this case, the adjustment can’t be higher than 2 percentage points over the previous rate.
• Lifetime cap: The final number reflects the lifetime cap. If you have a 2/2/5 cap, the interest rate can’t rise 5 percentage points above your initial rate.

Loan terms

When you get a mortgage, you should also consider how long it will take to pay it off. A 7/1 ARM commonly has a repayment term of 15 or 30 years, which means your interest rate would be fixed for the first seven years and then variable for the remainder of the term.

A home loan calculator can help you determine what your payment might look like at a certain interest rate. You can calculate how your costs compare over the first seven years for different loan types, as well as project what your overall costs would be if your rate adjusts to near the cap.

Pros and cons of a 7/1 ARM

A 7/1 ARM typically has a lower initial rate, which makes it an appealing option, especially if you’re planning to move or refinance before the adjustment period begins.

However, should you decide to keep the loan, you’ll need to be comfortable with the possibility that your monthly payment could go up. Plus, if rates continue to rise, you might end up paying more in interest over the long haul.

Here’s what to consider:

Learn More: ARM vs. Fixed Mortgage: How to Choose Between Them

In addition, if you refinance your mortgage, you must pay closing costs for the new loan. These can range from 3% to 6% of the loan amount: For a $250,000 loan, that can be $7,500 to $15,000 you have to pay upfront. If you’re considering an ARM for the lower initial rate, make sure that savings won’t be wiped out by future closing costs.

When to consider a 7/1 ARM

There are situations where a 7/1 ARM can be beneficial:

• A 7/1 ARM is a good option if you intend to live in your new house for less than seven years or plan to refinance your home within that time.
• An ARM tends to have lower initial rates than a fixed-rate loan, so you can take advantage of the lower payment for the introductory period.
• You might consider an ARM if you earn a variable income and expect to have more funds available in the future, meaning unpredictable monthly payments won’t be as difficult to manage.

If you sell the home before that seven-year period expires, you won’t have to worry about market fluctuations or changes to the interest rate and monthly payment.