Ask Bill your personal finance question

Comparing 7 year ARM to 30 year fixed loan

When looking at a 7/1 ARM and a 30 year fixed loans, What aspects of these loans should we be comparing?

Which one of these makes good financial sense considering that there is a 90% chance of selling the house before 7 years. What aspects of these loans should we be comparing? 1. 7/1 ARM 6.125 APR $1000 Closing 2. 30 year Fixed 6.25 % APR $7000 Closing

Read full question
Bill's Answer
3.5
/5.0
(6 Votes)

Updated: Sep 24, 2014

Bills.com | Find Learn Save

A 30 year fixed loan is a loan where the principal is repaid over a 30 year period and the interest rate your lender charges is fixed for the life of the loan. This contrasts from an ARM, which is an "adjustable rate mortgage" where the loan's interest rate is fixed for a short period of time and then readjusts for the remaining term of the loan to an adjustable market rate. If rates go down, you benefit... but if rates go up your rate will increase and your monthly payment could rise.

Adjustment Rate and Adjustment Period

For a 7/1 ARM, The interest rate will stay the same for the first 7 years. The term for this loan is 30 years. At the end of the first 7 years this loan will automatically adjust to an adjustable rate mortgage. Usually, the adjustable rate mortgage is a one-year Treasury Arm. The interest rate for this loan will adjust once per year. The first adjustment may be larger than the remaining adjustments. You should check to see if this loan has a cap on the maximum it would adjust at the first adjustment. The loan should also have a cap for the maximum percentage that it can adjust each year after the first adjustment. Usually, with a treasury arm loan the cap is 2% every year. You also need to check that this loan has a cap on the maximum percentage it can adjust during the term of the entire loan. Be sure to calculate your payment based on the total maximum payment your loan could ever reach. That way you will know if you can make that payment without any financial difficulty.

How Long in the Home?

Assuming that (according to what you stated) you end up selling the home before the 7 years, then the 7/1 ARM makes sense financially. However, as stated above make sure you find out the cap on the amount of maximum interest rates that can be charged. The reason for this is that under typical rate environments (including today's) there is a rising yield curve (the expectation of higher rates in the future) -- which means that shorter term rates are lower (in this case 7 year is lower than the 30 year fixed rate).

As for the 30 year fixed loan, make sure you find out in detail as to what the prepayment penalty clauses are, that would be an added cost on top of the interest and closing costs.

The best thing that you can do is to find a trusted mortgage broker and have him or her help you find the best mortgage loan for your needs. Bills.com makes it easy to compare mortgage offers and different loan types.

You can find in depth information on mortgages on our mortgage section.

There you will find current news articles, glossary of terms and even current interest rates.

I hope the information I have provided helps you Find. Learn. Save!

Best,

Bill

bills.com