Reader question: “I can see on the Freddie Mac website that 5-year ARM rates are almost always lower than the 15 and 30-year fixed mortgages, judging by their surveys. But they don’t have any data for the 7-year ARM listed on their site. Is that because it’s not a very common loan option? I was thinking about using the longer term ARM, because I will likely be in the home I’m purchasing for 6 years, or maybe a little longer than that. I want to get the lowest rate possible without having to worry about any adjustments. So the 7-year hybrid option sounds ideal for my situation, especially if it’s a money saver. Are 7-year ARM rates usually lower than 15 and 30-year fixed mortgages, on average?”
Let me start with your first question. Why doesn’t Freddie Mac list the average rates for the 7-year ARM, as they do for the 5-year ARM? Yes, you’re right. It is because the longer-term adjustable mortgage is less common. The 5-year is a more commonly used product, therefore it is included within the industry survey they conduct each month.
In fact, I just got an email from Freddie Mac the other day about the popularity of certain types of ARM loans. Here’s a quote that relates to your first question:
“The 5/1 hybrid (a five-year fixed-rate initial period before the rate resets annually) was by far the most common, followed by the 3/1, the 7/1 and the 10/1 option.” -Freddie Mac press release, January 28, 2014
When they talk about a “hybrid” product in this context, they are talking about an adjustable-rate mortgage that starts off with a fixed interest rate for the first few years, before switching to an adjustable loan. For example, the 7/1 hybrid ARM stays fixed (unchanging) for the first seven years, and then adjusts annually (every one year) after that initial period. It sounds like you know this already — I’m breaking it down for the benefit of other readers.
7-year ARM Loans Typically Have Lower Rates Than 30-Year Mortgages
So on to your next question: Are the 7-year ARM rates typically lower than the more commonly used 30-year mortgages, on average? The answer is yes, the 7/1 hybrid ARM usually has a lower interest rate than the 30-year fixed mortgage (FRM), on average. But this is only during the INITIAL stage of the adjustable loan, during which the rate remains fixed. Once it starts adjusting, all bets are off.
The 15-year fixed is a different story. You might actually be able to get a lower rate on the 15-year FRM than on the 7-year ARM. Or the other way around. The gap is much narrower with these two categories. So it’s hard to say. It will partly depend on the lender you use, which products they favor, and other factors.
It bears repeating: I am comparing the fixed periods of these different loan categories. For instance, I am talking about the difference between the initial (fixed) phase of the 7/1 hybrid ARM, and the lifetime rate assigned to the 30-year fixed mortgage. This is the only way to compare them, in terms of which one might be lower. You can no longer compare them after the ARM loan hits its first adjustment period, because the rate will begin changing every year at that point. It becomes a different animal. Make sense?
Here’s another quote that may interest you, from the aforementioned Freddie Mac press release: “Initial-period rates [in the beginning, when they remain fixed] on hybrid ARMs were up relative to last year with the largest rate increases for hybrids with longer initial fixed-rate periods, such as the 7/1 and 10/1 which rose by 0.71 and 0.76 percentage points, respectively.” This was from the first week of January 2014.
This partly explains why there is a distinction with how the interest rates behave in the 5-year and 7-year ARM categories, versus the 15- and 30-year fixed mortgages. The shorter 5/1 adjustable is considered a short-term product, while the 7/1 adjustable is considered a medium-term product.
Disclaimer: Every lending scenario is different, because every borrower is different. As a result, there may be cases where the trends noted above do not apply. This article deals with averages and typical scenarios. There are exceptions to every rule when it comes to home loans. This information has been provided for educational purposes only and does not constitute financial advice. The rate you receive from a mortgage lender will depend on a wide range of factors including your credit score, points paid at closing, the size of your down payment, and the type of loan product you choose.
Brandon Cornett
Brandon Cornett is a veteran real estate market analyst, reporter, and creator of the Home Buying Institute. He has been covering the U.S. real estate market for more than 15 years. About the author