What is a 7-year interest-only ARM?
Most mortgages require you to pay principal and interest monthly. Not interest-only loans.
These home loans require you to pay only the interest due, tremendously reducing your monthly cost.
These loans aren’t for everyone, though. You could go years without paying down a cent of principal. And, the rate could eventually adjust upward.
But for the right kind of buyer, they could be the antidote to high rates and home prices.Check your interest-only mortgage eligibility.
What’s in this article?
How does a 7-year interest-only ARM work?
A 7-year interest-only adjustable-rate mortgage (ARM) comes with a fixed rate for seven years. Then, it can adjust with the market. This is similar to most ARM loans.
However, it comes with an additional feature, known as an interest-only option.
During the interest-only period, you’re required to pay just the interest due each month. This is different than a “fully-amortized” mortgage, for which you pay principal and interest. The interest-only feature drops your required payment significantly.
When the interest-only period is up, it will turn into a fully-amortized loan.
For example, you could have a 7-year ARM with a 10-year interest-only period. Then, payments will adjust so that you pay off the loan over the next 20 years.
During the interest-only period, homeownership is much more affordable. You can pay down principal if you’d like, but it’s not required.Start your mortgage approval.
Why do some homebuyers choose an interest-only loan?
Most homebuyers choose an interest-only loan to reduce their monthly payment.
With rates and home prices rising so quickly, you might find that you can’t afford the same home that you could a month ago. Well, what if you only had to pay interest each month? Here’s the payment comparison on a few scenarios.
|20% down payment||$80,000||$120,000||$160,000|
|30-year fixed payment**||$2,023||$3,034||$4,045|
*Interest rates shown are for example purposes only and may not be currently available. Your rate will be different. Get a personalized mortgage quote here. **Does not include taxes, insurance, HOA, or other dues or fees.
The monthly savings are significant. The interest-only payment would be approximately $600 per month less than the payment for a 30-year fixed $640,000 loan with 20% down.
How to calculate your 7-year interest-only payment
You don’t need an interest-only mortgage calculator to figure out your payment. Here’s the formula.
Loan amount X interest rate / 12
So a $500,000 loan amount at 6.5% would look like this:
$500,000 X 0.065 = $32,500 (yearly interest) / 12 = $2,708 per month.
With a few keystrokes, you can calculate about how much your interest-only loan payment would be.
Who are 7-year interest-only loans good for?
These loans have many purposes. They are not just to reduce your payment to afford more home, although that’s a good use case. Here are individuals who might benefit:
2021 and early 2022 home shoppers: Mortgage rates and home prices have shot up like few times in history. An interest-only loan could help you afford the home you really want.
Buyers with variable income: With a 7-year interest-only loan, you have the option to pay down principal when you’re able to. But during months of lower income, you can choose the interest-only option.
Buyers who expect a large sum of money soon: Unlike a 30-year fixed loan, making a large payment toward principal will reduce the amount you owe each month. You only pay interest in the outstanding balance. If you expect a large bonus or inheritance in the future, you could reduce your mortgage payment without refinancing.
Those who might sell or refinance soon: According to the National Association of Realtors 2021 Profile of Home Buyers and Sellers, the average person stayed in their home just eight years. Most people sell or refinance before or shortly after the fixed period of this loan.
7-year interest-only mortgage pros and cons
- Lower initial payment during the interest-only period, helping you afford more home
- Option to pay down principal
- Mortgage payments drop as you pay down principal
- The rate is fixed for seven years, then there are limits on how much it can adjust
- You might end paying down little or no principal
- The rate can adjust upward at the end of the fixed period
- Eventually, you’ll have to pay principal and interest, which will cause your payments to increase significantly
- Might only be available to higher credit and higher net worth individuals, depending on the lender
7-year IO ARM alternatives
Standard adjustable-rate mortgages
Interest-only adjustable-rate mortgages
- 3-year interest-only ARM
- 5-year interest-only ARM
- 10-year interest-only ARM
7-year interest-only loans aren’t the dangerous loans of the past
Many homebuyers might fear an interest-only loan because it harkens to the mid-2000s when people lost their homes by getting into complex loan types.
Back then, many people received very short-term loans, such as 2-year ARMs or even 1-month ARMs, in which mortgage payments shot up quickly after closing.
A 7-year ARM offers a significant amount of time to increase your income, pay down the loan, sell, or refinance.
But some may have another objection: paying only interest. But with a 30-year fixed mortgage at 6.5%, only 15% of your payment goes toward principal the first year anyway. It takes five years to pay off $32,000 of loan balance on a $500,000 loan, even with a fully-amortized loan. This isn’t a whole lot different than having an interest-only loan.
Paying down zero principal for the first five to seven years is often worth it to secure a home that suits your needs.Find the best interest-only lenders here.
7-year interest-only FAQ
You can use an interest-only loan to purchase or refinance a home. Check with your lender about cash-out refinances.
After the interest-only period, the loan will convert to a loan in which principal and interest payments are due. The payments will rise accordingly. For instance, a 7-year ARM with a 10-year interest only period will need to be paid off in 20 years at the end of the interest-only period. The payment on a $500,000 loan at 6.5% would rise from $2,708 per month interest-only to $3,728 per month on the 20-year amortized period. While the payment increase is significant, most people sell or refinance before the interest-only period expires.
Some lenders make the fixed period and interest-only period the same. For example, a 7-year interest-only ARM would come with a 7-year interest-only period. It would also start adjusting after seven years. This isn’t ideal, because you get hit with the fully-amortized payment and a potential upward rate adjustment at the same time. That’s why some lenders now offer a 10-year interest-only period on 7-year interest-only loans.
After the 7-year fixed period, the loan will adjust to market rates. Most ARMs come with rate caps, which limit the amount the rate can rise at each adjustment. For instance, a loan at a 6.5% start rate might have 2/2/5 caps. In this case, the maximum increase would be 8.5% at the first adjustment, 10.5% at the second adjustment, and 11.5% at any time during the loan. This doesn’t mean the loan is guaranteed to rise this much; these are just the limits. It’s even possible that the rate could go down.
Is a 7-year interest-only loan right for you?
These loans aren’t the right choice for everyone, but they can make the difference between affording a home or not.
Examine your goals and situation, and consider buying a home with this program.Start your 7-year interest-only loan now.