7/1 ARM Loan: What Is It and How Does It Work?

The 7/1 adjustable rate mortgage (ARM) loan, also known as the 7-year ARM, can make homeownership more affordable but can be financially devastating if interest rates go up after the first seven years instead of down. While it can make real estate ownership more attainable initially, it’s usually not a good idea to use this kind of loan unless you plan to sell your home or refinance within the first seven years. But even that can be risky—you never know what the real estate market will look like seven years from now.

What is a 7/1 ARM loan?

A 7/1 adjustable-rate mortgage is a loan with a fixed rate for the first seven years, followed by a rate that adjusts annually for the remainder of the loan term.

7/1 ARMs are considered a hybrid adjustable-rate mortgage, as they combine a fixed-rate period with an adjustable-rate period. In many cases, the number preceding the slash signifies the fixed-rate period (7 years), and the number after the slash represents the number of years between each rate adjustment (in our case, yearly).

How does a 7/1 ARM work?

During the first seven years, known as the “introductory period,” your interest rate (also referred to as the “teaser rate”) will be fixed, typically at a lower percentage than standard fixed mortgages. For each of your monthly payments during these years, your payment will remain the same, providing predictability and stability.

After seven years comes the “adjusted period,” during which the rate changes once a year for the remainder of the loan. Your interest rate during this period will be a combination of two factors: index and margin.

• Index is a published benchmark rate that fluctuates periodically based on economic conditions (often based on Secured Overnight Financing Data (SOFR). 
• Margin is a fixed interest rate set by the lender and added to the index rate as part of their profit.

Additionally, borrowers have protections in place known as rate caps. There are three kinds of rate caps typically built into 7/1 ARM loans:

• Initial adjustment cap — A limit on how much the interest rate can either increase or decrease when the adjustable-rate period begins.
• Subsequent adjustment cap — A limit on how much the interest rate can change each time the rate adjusts (yearly on a 7/1 ARM).
• Lifetime adjustment cap — A hard limit on how much the interest rate can change over the life of the loan.

Each of these caps protects buyers from being unable to repay a mortgage down the road and lenders from losing money due to a too-low rate. Refer to the cap structure in the loan estimate to better understand the specifics for the mortgage you’re considering.

Who should consider a 7/1 ARM?

A 7/1 adjustable-rate mortgage can be a great option for people who fit the following criteria:

• Those considering selling their home or refinancing within seven years of the introductory period
• Homebuyers expecting to have a significantly higher income in seven years’ time (newly graduated doctors, for example)
• Buyers who want the lower initial rates to be able to afford certain purchases now (e.g., weddings, all-new furniture)
• Those with a higher risk appetite who are comfortable with annually variable payments and potential rate increases

Other ways to get a lower interest rate

If you’re looking for a lower mortgage interest rate but aren’t thrilled with the uncertainty of 7/1 ARMs, here are some other ideas to consider:

• Make a larger down payment: As opposed to the zero-down mortgage, more money down can get you a better rate, as you’ll have more equity in the home at the start and the lender’s risk will be lowered.
• Shop around: There are many reputable mortgage brokers, banks, credit unions, and other lenders available who can offer you quite different terms.
• Shorten the term: Though it’ll increase your monthly payments, a 20-year or 25-year mortgage may offer lower rates and significantly less interest paid over the lifetime of the loan.
• Buy points: Your lender may offer to let you buy “mortgage points” at the start of the loan, which can lower your interest rate. However, it can be costly (typically around 1% of the mortgaged amount) and may only apply to the teaser period on a 7-year ARM.

7/1 ARM: pros and cons

Unless you can find a $0-down, 0% fixed-rate mortgage, each mortgage type will have its advantages and disadvantages. Here’s what to know about the 7/1 ARM:

7/1 ARM example

Let’s look at a simple example of how a 7-year ARM would work with a $500,000 home mortgaged at $400,000 (20%, or $100,000, down payment):

As you see, while our fictional buyer enjoys seven years at a relatively low 5% rate, things get significantly pricier once the adjusted period begins. That’s because the adjusted rate will include the benchmark for the index rate plus margin, which can typically add another 2–3%.

Now, let’s look ahead five more years with an economy that’s booming and interest rates that have adjusted to match:

As you can see, only 4.5 percentage points separate the highest rates from the lowest in our scenario, but that’s a $1,138.88 difference in your monthly payment!

5/1 ARM vs. 10/1 ARM vs. 7/1 ARM: quick comparison

A 7/1 ARM is a good middle ground when comparing adjustable-rate mortgages, offering a longer fixed-rate period than a 5/1 ARM and a lower introductory rate than a 10/1 ARM.

As you decide among these options for adjustable rate mortgages, here are a few things to consider:

• Think about how long you’re planning to own the property before trading up.
• Review the rate cap structure of your loan to understand the maximum you might need to pay in a worst-case scenario.
• Assess your risk tolerance and what your future might hold in 7 years.

7/1 arm loan: Great if rates are high and you’ll move soon

A 7/1 adjustable-rate loan is a great option to consider during periods of high interest rates and for those who aren’t planning to keep the property longer than that period. 

However, this mortgage type will require you to prepare for the uncertainty that comes with not knowing what the economy will look like in seven years. Consult a financial advisor, shop around, and compare both lenders and mortgage types before you settle on a 7/1 ARM or any other loan.