If you sell your house or refinance your loan during the first seven years of your loan, then a 7/1 ARM (Adjustable Rate Mortgage) can save you money. Your loan, based on a 30-year payment schedule has a lower interest rate than a 30-year FRM (Fixed Rate Mortgage) and lower monthly payments.
However the 7/1 ARM carries the risk of a higher interest rate and higher payment after the initial period. If you cannot refinance or pay off the loan, then your overall costs may be higher than a fixed rate mortgage.
An adjustable rate mortgage is more complex than a fixed rate mortgage. Before you choose a loan understand the risks and benefits. Learn about:
- 7/1 ARM terminology
- Monthly Payments – Different Scenarios
- Choosing an ARM
7/1 ARM Terminology
The interest rate and monthly payment of a 7/1 ARM is set as follows:
- Initial Period. In a 7/1 ARM the interest rate is fixed for an initial period of 7 years. (The interest rate for a 5/1 ARM is 5 years and a 10/1 ARM 10 years).
- Periodic Changes. The interest rate can fluctuate every year based on the periodic caps.
- Technical terms. An ARM comes with some technical terms. Make sure that the lender gives you the details about:
- Periodic caps: How much can the interest rate increase at each periodic change? Will interest rates over the cap be carried over to the next period? Also, how much can the interest rate change on the first change after the 7 year period.
- Lifetime caps or ceilings: What is the lifetime cap on the loan?
- Floors: Is there a minimum interest rate?
- Index and Margin: What is the base rate for the interest rate at the time of the periodic change and how much is the margin over that rate? How does that compare with today’s rate? Two common indexes are the 1-year T-bill and the 1-Year USD LIBOR rate. Here are some rates for June 2012: the margin is currently 2.25% plus LIBOR for LIBOR ARMS and TBill ARMS are at 2.75% plus TBill .
When looking at different loan options, compare mortgage rates and mortgage fees including origination points, discount points and other lender related fees. In addition, check if there are prepayment penalties, and if so at what time they exist. (Some lenders have prepayment penalties if you pay before the end of the first period. In some cases it applies if you sell or refinance and in other cases only if you refinance).