With mortgage rates higher than many buyers became accustomed to over the last several years, affordability continues to be one of the biggest concerns for homebuyers.

The good news? A traditional 30-year fixed mortgage isn't the only financing option available.

Programs such as a 7-year adjustable-rate mortgage (ARM) and a 2-1 temporary interest rate buydown can potentially give buyers a lower initial mortgage payment and more flexibility — especially when a home builder or seller is contributing toward the financing.

But these are two very different loan programs, so it is important to understand exactly how each one works.

What Is a 7-Year ARM?

A 7-year ARM is an adjustable-rate mortgage that starts with an initial fixed-rate period.

For example, with a 7/6 ARM, your initial interest rate is fixed for the first seven years. During those seven years, your rate does not change.

After the seven-year fixed period ends, the interest rate becomes adjustable. With a 7/6 ARM, it can typically adjust every six months after that.

That does not mean your interest rate automatically shoots up after seven years.

Instead, the new rate is generally determined by a specified market index plus a margin established by the lender, subject to the adjustment caps contained in your loan.

Depending on market conditions at the time, the rate could potentially be higher or lower. The exact adjustment rules, rate caps, index and margin depend on the specific loan.

What Happens After the 7 Years?

This is one of the biggest questions I hear from buyers considering an ARM.

Your rate doesn't simply "jump to the current mortgage rate" on the first day of year eight.

Instead, your loan follows a formula outlined in your mortgage documents. Generally, the lender uses:

Index + Margin = Adjusted Interest Rate

The loan also has caps that limit how much the interest rate can change at the first adjustment, at subsequent adjustments and potentially over the life of the loan.

If you have a 7/6 ARM, your rate may then adjust every six months based on the terms of your loan.

This is why buyers considering an ARM should review not only the attractive introductory rate, but also the index, margin, adjustment frequency and rate caps.

Can You Refinance a 7-Year ARM Before It Adjusts?

Yes, assuming you qualify for refinancing at that time and the new loan makes financial sense.

You don't have to wait until the seven-year period is over to refinance.

For example, imagine you purchase a home with a 7-year ARM today. A few years from now, mortgage rates decline enough that refinancing into a fixed-rate mortgage makes sense.

You could potentially refinance the ARM into a new mortgage before the adjustable period ever begins.

Of course, refinancing is never guaranteed. Your future interest rate, credit, income, property value, equity and other lending requirements can all affect your ability to refinance.

That's why I recommend looking at an ARM as a loan you should be comfortable with based on its actual terms — not simply assuming you'll refinance later.

What Is a 2-1 Buydown?

A 2-1 temporary buydown works differently from an ARM.

With a 2-1 buydown, the underlying mortgage has a note rate established at closing, but funds contributed toward the buydown temporarily reduce the borrower's effective monthly payment during the first two years.

Here's a simple example using a 6.5% note rate:

Year 1: Payment is calculated as though the rate were 4.5%
Year 2: Payment is calculated as though the rate were 5.5%
Year 3 and beyond: Payment is based on the full 6.5% note rate

The key distinction is that the mortgage rate isn't adjusting with the market after year two if the underlying loan is a fixed-rate mortgage.

The temporary buydown simply ends.

That means if market mortgage rates are 7% when your third year begins, your loan doesn't automatically become 7%. Your payment moves to the payment associated with the note rate you agreed to when you purchased the home.

Can You Refinance During a 2-1 Buydown?

Potentially, yes.

If mortgage rates fall during the first or second year and you qualify for a refinance, you may decide to refinance rather than wait for the temporary buydown period to end.

Before doing so, you'll want to speak with your lender about the costs of refinancing and how any unused buydown funds would be handled under your particular agreement.

The goal isn't to refinance simply because you can. The numbers need to make sense.

Why Are 7-Year ARMs and 2-1 Buydowns Attractive in Today's Housing Market?

The biggest advantage is short-term affordability.

When mortgage rates are elevated, even a relatively small reduction in the interest rate can make a noticeable difference in a buyer's monthly principal and interest payment.

This can be particularly valuable when purchasing new construction, because some builders offer financing incentives through their affiliated or preferred lenders.

Instead of reducing the home's purchase price, a builder may contribute substantial funds toward financing incentives, closing costs or temporary/permanent rate buydowns.

Depending on the offer, reducing the mortgage payment can sometimes have a larger immediate impact on a buyer's monthly budget than a comparable reduction in purchase price.

However, every incentive should be evaluated based on the actual numbers. Buyers should compare the purchase price, loan costs, APR, monthly payments, future payment scenarios and available alternatives.

7-Year ARM vs. 2-1 Buydown: What's the Difference?

The easiest way to remember the difference is this:

A 7-year ARM: Your initial interest rate is fixed for seven years. After that, the rate can adjust periodically based on the loan terms and market index.

A 2-1 buydown: Your payment receives a temporary subsidy for two years. After the buydown ends, you pay based on the note rate established at closing. If the underlying mortgage is fixed-rate, it does not begin adjusting with the market.

Both strategies can lower the initial cost of homeownership, but they accomplish that goal differently.

What Should Buyers Ask Before Choosing an ARM or Buydown?

Before choosing either option, ask your lender:

  • What is my actual note rate?
  • How long is the introductory or buydown period?
  • What will my principal and interest payment be each year?
  • If this is an ARM, what are the index, margin and rate caps?
  • How frequently can the ARM adjust after the initial period?
  • What is the highest rate and payment allowed under the loan?
  • Is there a prepayment penalty?
  • What happens to unused buydown funds if I refinance or sell?
  • What would the same home cost me using a traditional fixed-rate mortgage?

Understanding the answers to these questions makes it much easier to compare your options.

Are Adjustable-Rate Mortgages Bad?

Not necessarily. They're simply a different financial tool.

An ARM may make sense for certain buyers who want to take advantage of a lower introductory rate and understand the possibility of future adjustments.

For other buyers, the predictability of a fixed-rate mortgage may be more important.

The important thing is to understand the loan you're agreeing to and make sure you could handle the payment if rates eventually adjust higher.

Is a 2-1 Buydown Worth It?

A 2-1 buydown can be especially attractive when the seller or builder is paying for it.

It provides lower initial payments while a buyer settles into homeownership. That can free up cash during the first couple of years for moving expenses, furniture, improvements or simply adjusting to the expenses associated with owning a home.

But buyers should still budget based on the eventual full payment — not just the first-year payment.

Should You Choose a 7-Year ARM, 2-1 Buydown or Fixed-Rate Mortgage?

There isn't one mortgage program that works for every homebuyer.

The right financing strategy depends on your purchase price, down payment, income, credit, how long you expect to own the home, available builder or seller incentives, and your comfort level with future payment changes.

This is especially important when comparing new construction financing incentives with resale homes. A builder may offer substantial financing incentives that aren't available from an individual home seller, so comparing only the home's purchase price doesn't always tell the whole story.

Before making a decision, ask your lender to show you the numbers side-by-side.

Looking for a Home in Santa Clarita?

If you're considering buying a home, new construction or resale property in Santa Clarita, Valencia, Saugus, Stevenson Ranch, Canyon Country, Newhall or the surrounding areas, I can help you compare your options and understand the real estate side of the transaction.

Financing programs can change, and loan eligibility depends on the individual borrower. Always review the specific loan terms with a qualified mortgage professional before choosing a mortgage.

Jessica Ranuschio | Home661