7/6 ARM Loan: What It Is, And How It Works

Written by Elijah BishopUpdated: 22nd Mar 2022
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With 85% of homebuyers choosing a fixed-rate mortgage over other mortgage types, it’s typical for the average first-time homebuyer to opt for fixed-rate loans. However, adjustable-rate mortgages (ARMs) may offer cheaper interest rates because the rate will adjust after the initial set period.

A unique type of ARMs is hybrids loans which feature a reduced fixed rate for a specific length of the life of the loan. One common type of hybrid ARM mortgage is the 7/6 ARM, which offers a cheaper fixed rate for the first seven years of the term and is an appealing alternative for home buyers.

Read on to learn more about this option and if it could be right for you.

What Is a 7/6 ARM Loan? 

An adjustable-rate mortgage, or ARM, is a house loan whose interest rate can alter over time. A hybrid, such as the 7/6 ARM, combines the benefits of a fixed-rate mortgage and an adjustable-rate mortgage.

Here is what the two numbers mean:

  • The first number is the number of years your interest rate will remain fixed.
  • The second number is the frequency with which the rate will be adjusted annually following the fixed term.

For example, if you had a 7/6 ARM with a 30-year term, your mortgage interest rate would be fixed for the first seven years. After that, your rate and payment would adjust every six months for the next 23 years.

>> More: Best Mortgage Lenders

How Do 7/6 Adjustable-Rate Mortgages Work? 

Because ARMs vary over time, you may wind up with a lower or larger monthly payment depending on whether interest rates rise or fall. Your payment will be adjusted to guarantee that you pay off your mortgage on time.

With a 7/6 ARM mortgage, changes to the interest rates only occur after the original seven-year fixed-rate period. In addition, there are several restrictions on how much the interest rate can adjust after the end of the fixed-rate period.

In the following section, we’ll provide a more in-depth look into how 7/6 ARMs work:

Understanding 7/6 ARM Loans 

When evaluating their loan alternatives, borrowers should be aware of several essential components of a 7/6 ARM.

Interest Rates 

Because the initial interest rate is only fixed for seven years, future rates and payments might change considerably following the rate adjustment depending on the ARM and the current market. Even if interest rates remain consistent, your monthly payments may vary dramatically throughout the loan.

More importantly, the index to which it is linked, the margin, interest rate caps, floors, and intervals all impact 7/6 ARM interest rates.

>> More: How Are Mortgage Rates Determined?

Interest Rate Caps and Floors 

Even though a 7/6 ARM’s mortgage rate regularly rises after the first fixed period, there are limits to how high the rate can go. Caps are frequently based on a first adjustment, additional adjustments, and a lifetime cap. The 2/2/5 cap is typical. This is how the cap system works:

  • Initial Adjustment Cap: The first number indicates the initial adjustment cap. This is the first time the lender has changed the rate after the fixed period. The rate can’t be more than two percentage points higher than your initial rate under the 2/2/5 cap, regardless of how much interest rates have risen since you took out your loan.
  • Subsequent Adjustments Cap: The second number is the cap on the following adjustments. The adjustment can’t be more than two percentage points greater than the previous rate in this scenario.
  • Lifetime Cap: The lifetime cap is reflected in the final number. With a 2/2/5 cap, the interest rate cannot rise more than five percentage points above the initial rate.

>> More: How to Choose the Best Mortgage

Adjustment Periods 

An ARM’s interest rate and monthly payment may alter every month, quarter, year, three years, or five years. The period or interval between rate changes is the adjustment period or interval.

The introduction period for a 7/6 ARM is seven years, after which the interest rate might adjust every six months. Remember that not all ARM loans will adjust downward, even if market activity suggests they should. That is why, before proceeding, you should study the fine print of your mortgage agreement.

Margin

ARM lenders add percentage points to indexes to set the interest rate. This determines the rate you’ll pay during the life of the loan. Lenders must disclose this margin to you before you sign. Often, your lender adds a fixed percentage to the index rate to calculate your new interest rate. For example, if you have a 3.5 percent margin and your rate adjusts based on the SOFR — and the SOFR is 0.15 percent — your new mortgage rate is 3.65 percent.

Financial Market Indexes 

An index is commonly used to express current market conditions. Online mortgage lenders in the past typically used the London Interbank Offered Rate (LIBOR). However, LIBOR is being phased out, and many US lenders are now using the Secured Overnight Financing Rate instead (SOFR). The Constant Maturity Treasuries (CMT) and the Cost of Funds Index are two other indexes that could be employed (COFI).

What Are the Benefits of 7/6 ARM Loans? 

  • Lower interest rate at first: A lower starting rate means a reduced mortgage payment for the first seven years of your loan. You can opt to invest the difference, pay down principal, or make home renovations.
  • Could pay less in interest: If interest rates continue low (or perhaps fall), you may be able to save money on total interest. Furthermore, if you apply the difference in your monthly payment versus a fixed-rate mortgage to the principal, you may be able to reduce the sum on which you’re paying interest, saving you even more money.
  • If you’re planning to relocate soon, this will be useful: If you know you’ll be moving within seven years, you could save money by selling your home before the rate adjusts.

What Are the Risks of 7/6 ARM Loans? 

  • Mortgage payments may rise: Your mortgage payment may also increase if interest rates rise after the first seven-year fixed period. Even if the higher rates are capped, they could considerably impact your budget.
  • Interest could become more expensive throughout the loan: If mortgage rates continue to rise, even with restrictions, you may wind up paying more in interest.
  • It’s possible that the rate difference isn’t worth the stress: The interest rate difference between a fixed-rate loan and a 7/1 ARM can be little at times. As a result, choosing a fixed-rate loan with a larger initial payment can be the better option in the long run. 

How Much Does a 7/6 ARM Loan Increase? 

All adjustable-rate mortgages contain lifetime caps, which limit, or “cap,” the maximum interest rate imposed on the loan. These restrictions are expressed as a percentage increase above the initial, fixed-interest rate. For example, if your 7/6 ARM had a lifetime ceiling of 4% and started at 3%, your interest rate would never increase over 7%, regardless of market changes.

ARMs also contain periodic limitations, limiting how much the interest rate can change in a single adjustment period. So, for example, if your 7/6 ARM has a periodic cap of 0.75 percent, your interest rate will never rise more than 0.75 percent in any six months, even if interest rates rose by 2% or 3%.

Is a 7/6 ARM a Good Idea? 

A 7/1 ARM is a suitable option if you plan to dwell in your new home for fewer than seven years or if you plan to refinance within the same term. Because an ARM often has lower initial rates than a fixed-rate loan, you can benefit from the lower payment during the introductory period.

If you sell your house before the end of the seven years, you won’t have to worry about market swings or adjustments in your interest rate or monthly payment. You can also refinance before the period ends, but there usually are closing expenses that will increase the overall cost of your mortgage.

Bottom Line: 7/6 ARM Loans

A 7/6 ARM is worth considering if you are convinced that you will be able to make your monthly payments even if the interest rate reaches the maximum level. If you believe you will only be in your house for a short time before selling, a 7/6 ARM loan may be worth the risk. This allows you to take advantage of the cheaper monthly payments.

If you’re considering a 7/6 ARM, shop around for various lenders. Comparing your options with multiple mortgage lenders is an excellent way to end up with a great bargain.

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Elijah Bishop
Elijah Bishop

Elijah A. Bishop is a Senior Personal Finance Writer who has been writing about real estate and mortgages for years. He has a Bachelors of Arts Degree in Creative writing from Georgia State University and has also attended the Climer School of Real Estate. He also holds a realtor license and has been in and out of the US mortgage industry as a loan officer. Bringing over 15 years of experience, Elijah produces content that analyzes ethnicities, race, and financial well-being. His areas of expertise are mortgages, real estate, and personal loans.