The 7-Year Mortgage: Take It or Leave It?
My credit union has been promoting a seven-year mortgage. This type of loan could be perfect for someone who needs to pay off a mortgage quickly, or so I thought. But then I found out that there are many types of seven-year mortgages. Oddly, many have 30-year terms, and at least one type could easily put homeownership at risk.
You’ll have to read the fine print of your mortgage contract to scrutinize its terms, but most fall into the following categories.
1. The 7-Year, Fully Amortizing Loan (Paid Off in 7 Years!)
This type of loan is just what I imagined it to be. The schedule of payments is compressed so that the loan balance is paid within seven years. My credit union offers this home loan as a first mortgage only.
It seems perfect for the borrower who wants to 1) get a low rate and 2) match the loan payoff with the timing of a major lifestyle change, such as the start of a new business or retirement. (See also: What's faster for mortgage payoff: $100/month extra or 1 payment/year extra?)
2. Interest-Only for 7 Years, Then Fully Amortizing Loan (Paid Off in 30 Years)
The payments are relatively low for starters, as you will pay only interest during the first seven years. But your loan balance remains the same during this time, even if you make all the payments according to schedule.
After seven years, your payment will be adjusted to amortize the loan over the remaining term (typically 23 years). If you signed up for an adjustable rate mortgage (ARM), then your interest rate will reset also. The result could be a hefty monthly increase.
This type of loan could be the most expensive in terms of interest paid.
3. 7/2 — Fixed Rate for 7 Years, Adjustable Rates for Subsequent Years (23-30)
This ARM starts with a fixed rate with a stable monthly payment for seven years. After the initial term, the interest rate resets at regular intervals (every two years) and the monthly payment is recalculated.
4. 7/23 — Balloon/Reset Mortgage
The balloon/reset mortgage is the kind that could be dangerous.
The first seven years are uneventful, as the interest rate is fixed and monthly payments stay the same.
But at the end of seven years, the entire balance is due unless certain provisions are met. According to Freddie Mac, these requirements usually include:
- You're still the owner and occupant of the home.
- You've paid your mortgage on time for at least a year prior to the balloon note maturity date.
- You have no other liens against the property.
- You've satisfied any other conditions of the reset.
If you qualify for the reset, then a new monthly payment is calculated and the loan balance is amortized over the remaining term. (A borrower could also refinance the loan but this scenario is not represented in the downloadable amortization schedule).
If you don't qualify for the reset (and are unable to refinance the mortgage), then you will need to pay the outstanding balance (that is, make a balloon payment) at the end of seven years. Failure to make this payment can trigger foreclosure, so be careful with this type of mortgage.
I built a spreadsheet to illustrate how these mortgages work. You can see how payments are calculated and how borrowed amounts and outstanding loan balances are amortized over the term of the loan. The total interest paid is calculated for each loan type so that you can see the impact of various loan structures on total cost.
To customize the spreadsheet, download the file, then enter your loan balance, starting interest rate and interest rate caps (these cells are in orange). Note that I have established rate caps and time frames that seem reasonable; you may need to refine the spreadsheet for your own mortgage.
Have you considered a seven-year mortgage loan? What made you decide to take it or leave it?