Homebuyers tend to gravitate toward fixed-rate mortgages, but in some cases, an adjustable-rate mortgage is a better option. If you’re considering an ARM, you have several choices. A loan with a fixed rate for the first seven years might be the best one for you.
How an Adjustable-Rate Mortgage Works
With an ARM, the interest rate is fixed for an initial period, which varies by loan type. If you take out a 7/1 adjustable-rate mortgage, that means your interest rate will be fixed for the first seven years.
After the fixed-rate period ends, the interest rate will reset every year based on market conditions at the time. The rate may go up or down. There is usually a limit on how high the interest rate can go and how much it can rise each time it resets.
The total term of an adjustable-rate mortgage might be 15 or 30 years. In that case, the interest rate will be fixed for an initial period, then it will adjust periodically until you pay off the loan, refinance, or sell the house.
Benefits of an ARM
People who choose adjustable-rate mortgages do so because they want to keep their monthly payments low in the period soon after they buy a house. When the interest rate resets, homeowners can accept the new rate, refinance to get a more competitive interest rate, or sell the house. Homeowners with ARMs who do one of these things before the rate rises can pay less overall in interest than they would pay with a fixed-rate mortgage.
Pros and Cons of a 7/1 ARM
A 7/1 adjustable-rate mortgage might be a good choice for you if you’re not planning to stay in your house for a long time. Perhaps you or your spouse has been transferred for work, and you know that the job in the new city will only be temporary. Maybe you’ve decided to buy a small starter home and upgrade in the future, when your incomes are higher.
Other types of adjustable-rate mortgages are available, but they might have shorter periods with fixed interest rates, such as three or five years. If you’re planning to stay in your house longer than that, or if you aren’t sure what might happen in the future, the security of having your interest rate locked in for seven years might appeal to you.
If you think you’ve found your forever home, however, you might prefer the stability of a fixed-rate mortgage. Although refinancing is an option with an ARM, you’ll have to pay closing costs. If you lock in a low fixed rate now, you’ll be able to avoid that additional expense later on.
You also have to consider your future earning potential. If you take out an ARM, your monthly loan payments might rise substantially. If you aren’t confident that you’ll be able to afford higher payments, you might be better off taking out a fixed-rate mortgage so you can avoid an unpleasant surprise later.
