If you’ve been shopping for a home, you’ve likely had to learn some new lingo. For instance, a 4/2 refers to a four-bedroom, two-bathroom house; the amount of time that a house has waited for buyers may be abbreviated DOM (days on market).
Shopping for a mortgage has its own linguistics — and the 7/6 ARM meaning can be inscrutable at first. The quickest definition: A 7/6 ARM is an adjustable-rate mortgage with an interest rate that remains fixed for seven years, before changing once every six months for the remainder of the loan term.
But who benefits from a 7/6 ARM, and what are its downsides? Good thing you asked — we’ve got answers below.
Explaining the 7/6 ARM
ARMs (adjustable-rate mortgages) are different from more common fixed-rate home loans because — you guessed it — their interest rate adjusts over time based on market conditions. However, the lender can’t just bounce the interest rate around willy-nilly. There are guidelines and, thankfully, caps in place. Here’s how it works:
Initial Fixed-Rate Period
As mentioned above, a 7/6 ARM has an initial fixed-rate period of seven full years. That’s what the “7” refers to — and what the number in place of the 7 refers to in other advertised ARMs. (For example, a 5/1 ARM has a five-year initial fixed interest rate; for the remainder of the loan, rates can be adjusted once per year.)
Because the interest rate will begin to adjust once the initial period is up, borrowers can often qualify for a lower interest rate during this initial fixed period than they otherwise would with a traditional fixed-rate mortgage (whose interest rate and monthly payments will be identical for the life of the loan).
Adjustment Period
The adjustment period is what begins once that initial fixed-rate period is over — so for a 30-year 7/6 ARM, the adjustment period lasts 23 years. (Most ARMs have 30-year terms; in fact, 30-year terms are the average mortgage term length among U.S. borrowers.)
During the adjustment period, the interest rate can be adjusted. For a 7/6 ARM specifically, adjustments can happen up to once every six months. That’s what the “6” refers to.
Interest-Rate Caps
Some good news for those who take out ARMs: Although rates can be adjusted (and, yes, go up if market conditions swing that way), there are built-in limits. For instance, you might see an adjusted-rate mortgage advertised the following way: 7/6 ARM 5/1/5. Don’t let the additional numbers scare you! They simply refer to the interest rate caps and floors.
In this example, the first “5” means 5.00% is the most your rate could rise or fall during the first adjustment, while the “1” caps how many percentage points it can rise and fall during each subsequent adjustment after that. Finally, the last “5” indicates that your loan’s rate won’t rise or fall more than 5.00% at any point over the lifetime of the loan. So, for instance, if your initial fixed rate was 6.00%, this cap means the rate will never be lower than 1.00% or higher than 11.00%.
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Pros and Cons of a 7/6 ARM
Now that you understand how a 7/6 ARM works, let’s talk about who it best works for — and when.
Advantages of a 7/6 ARM
The main benefit of an ARM is its lower initial interest rate — and 7/6 ARMs have one of the longest initial fixed-rate periods. While the rate may later shoot up by as much as 5.00% (or whatever your loan’s interest rate cap is), many people take out ARMs with the intention of using the lower interest rate to pay off the loan as quickly as possible — ideally before the adjustment period kicks in at all.
Disadvantages of a 7/6 ARM
The disadvantages of a 7/6 ARM are related to its benefits. While 7/6 arm rates initially may be low, rates may get much higher in the adjustment period. If you don’t successfully pay back the loan before it begins, you may find yourself with much higher monthly payments — and since it’s hard to predict what your financial circumstances will be seven years down the road, this can be a risky bet to make.
Qualifying for a 7/6 ARM
So, what does it take to successfully qualify for a 7/6 ARM? While each home loan lender has its own requirements as part of the mortgage process, there are some basic rules of thumb to be aware of.
Credit Score Requirements
For starters, most lenders have a credit score floor of 620 for ARMs. (If you can qualify for a government-backed type of mortgage, such as an FHA loan or VA loan, that credit score floor may be lower.)
However, your credit score isn’t the only factor lenders assess when qualifying you for a loan. They’ll also look into your income and verify your employment, as well as considering your debt-to-income ratio or DTI — the measure of how much of your gross income each month is already tied up in making loan payments. In most instances, you’ll need a DTI ratio of 50% or less to qualify for an ARM.
When to Consider a 7/6 ARM
Given the specific risks and benefits of a 7/6 ARM, in what circumstances do they work best?
Those who are confident they’ll be able to pay off the loan before the initial fixed-rate period elapses could be well served by the upfront interest savings of this type of loan. Additionally, those who plan to sell their home within that initial seven-year period may also get the benefits of lower interest rates without following through on the adjustable-rate period.
Finally, people who are betting on a rise in income over the initial seven-year period may also be confident enough to take out a 7/6 ARM — but given how much higher your monthly payments could go at that time, this is a gamble best made with a lot of forethought.
Alternatives to a 7/6 ARM
Those who are interested in a 7/6 ARM might also consider ARMs with other terms, such as a 5/1 ARM or a 10/6 ARM.
Fixed-rate mortgages are also an option — one that offers predictability in both interest rate and overall payment amount. Of course, that interest rate may not be as low as the initial fixed rate period of an ARM.
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The Takeaway
A 7/6 ARM is an adjustable-rate mortgage with a seven-year-long fixed-interest-rate period, followed by an adjustment period where the rate can change every six months. ARMs can be risky for those who plan to keep the mortgage for its entire term, but for those who plan to sell their home or pay off the mortgage before the initial fixed-rate period elapses, they can be money-savers.
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FAQ
How is the interest rate on a 7/6 ARM calculated?
The interest rate on a 7/6 ARM — like any mortgage loan — is calculated using a wide variety of factors, including market conditions, the federal interest rate, the creditworthiness of the borrower and more. However, with an adjustable-rate mortgage specifically, that rate can change over time (sometimes tracking specific market indices). For the best information on how your loan is calculated, talk directly with your mortgage lender.
What happens when the initial fixed-rate period ends?
When the initial fixed-rate period of an adjustable-rate mortgage ends, the rate begins to be, well, adjustable — which means it can be changed (within the confines of the rate caps, floors, and adjustment intervals listed in the loan agreement). For example, with a 7/6 ARM, after the initial seven-year fixed interest period, the rate can be adjusted once every six months for the remainder of the loan’s term.
Can I refinance a 7/6 ARM before the adjustment period?
Yes, you can refinance a 7/6 ARM — or most any ARM — before the initial fixed-rate period is over and the adjustment period begins. However, it’s important to consider that refinancing comes with its own costs (which, like initial closing costs, can easily rack up to 3% or more of the total home value), so factor in those expenses when deciding what makes the most financial sense for you.
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