What is a 7/6 ARM?
A 7/6 ARM is an adjustable-rate mortgage fully amortized over 30 years. During the first 7 years of the loan, the interest rate will remain fixed at an initial start rate. For the remaining 23 years of the loan, the interest rate will adjust every 6 months.
What is the main benefit of an ARM?
Typically, the interest rate during the fixed portion of an ARM, seven years, in this case, is lower than that of a true fixed rate option. For example, the initial rate on a 7/6 ARM might be at 4.75% whereas an equal fixed rate option might be at 5.25%. Choosing the ARM product in this scenario would allow an individual to save 0.50% interest annually for the first seven years.
How does the interest rate adjust?
ARM’s contain two main components known as the margin and the index. The margin is determined at closing by the lender and remains the same for the life of the loan whereas the index fluctuates over time based on the current interest rate environment. As a result, the changes to the index ultimately determine the interest rate at each adjustment period.
Example:
At Initial Loan Signing
Margin=3%
Index=2.5%
Initial note rate: 3% + 2.5%=5.5%
After 7 Years
Margin=3%
Index=4%
New rate: 3%+4%=7%
*This will continue adjusting every 6 months
Can my interest rate increase indefinitely?
No. ARM’s contain interest rate “caps” which outline the maximum the interest rate can adjust at each period. There are a total of three caps: The initial adjustment, subsequent adjustments, and maximum total adjustment. The current cap structure of the 7/6 ARM is 5/1/5 (Initial/Subsequent/Lifetime).
When does an ARM make sense?
In general, ARM’s make the most sense during high-interest rate environments where individuals plan to sell or refinance their home before the fixed interest rate portion ends.
Example # 1: An individual would likely benefit from a 7/6 arm if he or she plans to sell their home within 5 years (before the fixed portion ends).
Example # 2: An individual would likely benefit from a 7/6 arm if he or she expects market interest rates to fall substantially sometime in the next seven years (before the fixed portion ends).
In both scenarios, the individual would be able to take advantage of the lower initial interest rate for the entire life of the loan. The best course of action is to speak with a mortgage lender to make sure employment, credit score, and finances are in order so you can feel confident taking on the responsibilities that come with homeownership. If you have any questions about the housing market and what your options may be, give us a call at (760) 930-0569 and one of our loan officers will assist you.
