7-Year Adjustable Rate Mortgage (7/6 SOFR ARM)

A 7-year Adjustable Rate Mortgage (ARM) is a home loan with an interest rate that stays the same for the first seven years, followed by adjustments every six months. After seven years, your payments will fluctuate every six months based on the new interest rate.

NewCastle's 7-year ARM is called a 7/6 SOFR ARM. Let's take a look at the features and how it works.

• 7/6: The "7" refers to the initial fixed-rate period of 7 years. The "6" means the interest rate adjusts every 6 months after the fixed period ends.
• SOFR: The lender adjusts the rate based on the Secured Overnight Financing Rate (SOFR), a benchmark index commonly used for ARMs.

Key features of the 7-year ARM

Start Rate

The initial fixed interest rate is for seven years.

Adjustments

The rate adjusts every six months after seven years.

Margin: 3%

The lender sets the margin, which doesn't change for the life of the loan.

Index: 30-day Average SOFR

After the fixed-rate period, the lender adds the SOFR index to the 3% margin to get the new interest rate.

• SOFR + Margin = Rate

Caps: 5/1/5

ARM caps limit how much the interest rate can change to protect you from sizeable monthly payment increases.

The 7-year ARM rate can increase by up to 5% at the first adjustment and up to 1% at subsequent adjustments. However, it cannot increase by more than 5% above the start rate over the life of the loan.

How the 7-year ARM works

Start rate

The rate and payment are fixed and won't change for seven years. 

First adjustment

After seven years, your rate adjusts, and the lender recalculates your monthly payments based on three numbers:

1. Current loan balance – How much you owe on the loan
2. New interest rate – The 3% margin plus the SOFR index
3. Remaining loan term – The loan's remaining 23 years

The lender uses these numbers to calculate your new payment so you pay off the loan by the end of the 30-year term. If the latest interest rate is higher or lower, your monthly payment will adjust up or down.

The first adjustment is capped at 5%, limiting the increase in the interest rate and reducing the risk of payment shock. The margin acts as the floor, meaning the interest rate can never be lower than 3%, no matter how much the index rate decreases. 

Subsequent adjustments

Your payments may fluctuate every 6 months based on the current loan balance, new interest rate, and remaining loan term. The lender caps the subsequent adjustments at 1%.

Lifetime cap

The 7/6 SOFR ARM has a 5% lifetime cap. The rate will be no more than 5% higher than the start rate.

Example: 7/6 SOFR ARM Scenario

Fixed period (Years 1–7)

• Initial loan amount: $900,000

• Start rate: 6%

• Monthly payment: $5,396 principal & interest

First adjustment (Year 8)

To adjust the interest rate and calculate the monthly payment for a 7/6 SOFR ARM, the lender follows these steps:

1. Look up the current SOFR index. Let's assume it's 4.5%.

2. Adjust the rate: 4.5% SOFR index + 3% margin = 7.5% new rate

3. Apply the caps: The initial adjustment cap limits the rate increase to 5% above the start rate. In this case, the rate will increase by only 1.5%.

4. Recalculate the monthly payment based on the remaining loan balance of $806,755, the new rate of 7.5%, and the remaining term of 23 years.

In this case, the payment for the next six months is $5,641.

Subsequent adjustments (Years 8+)

The lender repeats the steps to adjust the interest rate and calculate the monthly payment every six months. However, the adjustments are limited to 1%.

Why choose a 7-year ARM?

Opting for the 7/6 SOFR ARM can be a smart financial move. With a lower initial interest rate than a 30-year fixed, you can enjoy reduced monthly payments in the first seven years, saving you significant money. 

For example, if the $900,000, 30-year fixed mortgage rate is 0.75% higher, you would save more than $37,000 over seven years with the ARM, demonstrating the financial prudence of choosing a 7/6 SOFR ARM.    

• Loan amount: $900,000
• Monthly payment: $5,837
• Monthly savings: $441
• Total savings over seven years: $37,044

Who benefits from a 7-year ARM?

Understanding the potential savings and financial flexibility, a 7-year ARM can be a confident and informed choice for high-income earners, first-time buyers, and short-term homeowners. 

Physicians

If you expect your income to increase significantly in the next few years, an ARM with a lower initial interest rate may allow you to qualify for a larger loan or may allow you to make smaller monthly payments in the short term.

First-Time Buyers

Lower initial payments can make homeownership more affordable. Buyers looking for lower monthly payments at the start may prefer an ARM. The initial savings can make homeownership more affordable.

Short-Term Homeowners

Borrowers who plan to move, upgrade, or downsize within 5 to 10 years often benefit from ARMs. For instance, a family expecting to relocate in 6 years could use a 7/6 ARM to secure a lower rate without worrying about future adjustments.

The main risk with an ARM is that the rate will increase along with your monthly payments.

Is an ARM Right for You?

An ARM is an excellent choice if you prioritize lower initial payments and have a clear plan for the future. However, a fixed-rate mortgage is better if you keep the property long-term or are concerned about potential rate increases.

Contact us today to learn more about ARMs and find the best option for your home financing needs.

• SOFR ARMs Fact Sheet (Freddie Mac)

• SOFR Averages and Index Data (Federal Reserve Bank)