Question

1. What are some scenarios under which you would come out ahead with the 7/1 ARM? Think carefully about interest rate trajectories.

1. What are some scenarios under which you would come out behind with the 7/1 ARM? Again, think carefully about the interest rates.

Answer 1

A 7/1 ARM means there is an initial fixed interest rate for 7 years and then a rate adjustment after 7 years

Its very difficult to gauge the interest rate scenario after 7 years from today. If you take a 7/1 ARM and and the interest rates today are high. You will pay the high interest rates for 7 years. Now at the end of the seven years, if the interest rates are expected to cool off, then you can significantly pay a lower interest for the remaining 23 years assuming the mortgage was a 30 year mortgage. You will come out ahead with this strategy.

On the other hand, if you take a 7/1 ARM and and the interest rates today are low. You will pay the low interest rates for 7 years. Now at the end of the seven years, if the interest rates are expected to rise, then you can significantly pay a higher interest for the remaining 23 years assuming the mortgage was a 30 year mortgage. You will come out behind with this strategy.