What Is a 7/1 Adjustable-Rate Mortgage (ARM)?

A 7/1 adjustable-rate mortgage (ARM) is a mortgage loan with a rate that adjusts periodically.  Your rate is guaranteed for the first seven years, then adjusts once per year based on market conditions and rate caps. 

ARMs can save you money by offering a lower initial rate, but there's a risk your rate will increase over time, so you must make sure you understand how the loan works before borrowing. While Freedom Mortgage does not offer a 7/1 ARM, this guide explains how a 7/1 ARM works for informational purposes. Freedom Mortgage does offer 7/6 ARMs, which means the rate adjusts every 6 months (instead of every year) after the fixed term expires.

What Is a 7/1 ARM?

A 7/1 ARM is an adjustable-rate mortgage with a fixed interest rate for the first seven years. After that, the loan will undergo an annual rate adjustment for the remainder of the loan term based on the real estate market. A 7/1 ARM offers an initial interest rate that’s typically lower than standard fixed-rate mortgages, which have the same rate for the entire loan term.

Annual rate adjustments may result in an increase or decrease to your monthly mortgage payment. There are several types of ARMs, all classified by two numbers, like 7/1, which indicate the length of the fixed period and the frequency of rate changes.

How Does a 7/1 ARM Work?

To understand how a 7/1 ARM works, there are two phases to be aware of:

1. Fixed period: For the first seven years after closing on your 7/1 ARM, you’ll have a fixed interest rate, which means more predictable monthly mortgage payments.
2. Adjustable period: Beginning year eight of your loan, your interest rate, and therefore your monthly payment, will adjust annually.

You can choose different term lengths for a 7/1 ARM, with many people choosing a 30-year loan. As with other mortgages, your monthly payment includes principal and interest payments and sometimes tax and insurance payments that are put into escrow.

7/1 ARM Rates and Rate Caps

Each new rate is determined by adding your lender’s fixed margin to the market index your loan is tied to, such as the Secured Overnight Financing Rate (SOFR) or Constant Maturity Treasury (CMT). The market changes frequently, which means your interest rate, and, consequently, your monthly mortgage payment, may increase, decrease, or stay the same after each annual adjustment.

The thought of potential rate hikes after seven years might seem like a significant change to your budget. However, rate caps can offer some security by limiting how much your rate can increase (or decrease). Rate caps are usually presented as a series of three numbers, like 2/2/5.

Using the 2/2/5 example, here’s what those numbers mean:

• The first 2 represents the initial adjustment cap, which limits the first rate increase or decrease to a maximum of 2%. 
• The second 2 represents the periodic or subsequent adjustment cap, which limits how much the rate can change each annual adjustment, measured from the rate in effect immediately before that adjustment (not from the initial rate).
• The 5 represents the lifetime adjustment cap, which limits how much the rate can rise or fall over the life of the loan compared to your initial (starting) interest rate.

When Is a 7/1 Adjustable-Rate Mortgage a Good Fit?

Some homebuyers may be well-suited for a 7/1 ARM despite the potential for higher payments down the road. This could be the case if you’re:

• Planning to sell or refinance: If you expect to sell your home or refinance before the seven-year fixed period is up, you can enjoy the lower initial rate without worrying much about future adjustments. For example, some borrowers may opt for a 7/1 ARM when rates are low, with a plan to refinance before their rate could go up.
• Expecting higher earnings: If your income is likely to grow, you may feel more confident taking on potentially higher payments later.
• Open to flexibility: If you’re comfortable balancing lower upfront costs with the possibility of higher payments later, a 7/1 ARM may align with your financial strategy.

A 7/1 ARM is usually a good fit for buyers who understand how this loan type works, are comfortable with the potential long-term risks, and want to take advantage of a set interest rate for seven years. It’s important to weigh the potential pros and cons before applying.

Pros of a 7/1 ARM

Here are some of the benefits of choosing a 7/1 ARM.

• Lower initial payments: The fixed rate for the first seven years is often lower than the rate you would get with a fixed-rate mortgage, resulting in lower initial monthly payments.
• Predictability early on: You’ll have a more predictable payment for seven years. If you sell or refinance before that period ends, you may not face a rate change.
• Potential to save money: If interest rates decrease after the fixed period, your mortgage payments could go down.

Cons of a 7/1 ARM

Here are some of the disadvantages of a 7/1 ARM.

• Risk of rate increases: After the fixed period, your interest rate could increase, raising your monthly mortgage payment.
• Unpredictable budgeting: Adjustable rates make it difficult to predict your mortgage payments after the fixed period, and financial planning could be more challenging.
• Higher potential long-term costs: If interest rates increase significantly, you might pay more over the loan’s term than you would if you had a fixed-rate mortgage with a comparable term.