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What’s a Lucky 7 Loan?

Posted May 5, 2010 by Matthew Denton

Think you’ll strike good luck with this type of hybrid mortgage?

More often than not, you’re supposed to be allergic now to hybrid loans. Imagine the industry-wide devastation it brought to us. That’s not something you ask from a lender these days. But a founder of a New York City law firm thinks that you should consider one loan that may be useful in this financially tumultuous period. Edward Memelstein of Edward A. Memelstein & Associates, advices buyers to consider the Lucky 7 loan in the first week of April. He says, “Take advantage of the lower interest rates available with a 7/1 adjustable rate mortgage (ARM), when compared to a fixed-rate 30 year mortgage. The interest rate on a 7/1 ARM is fixed for seven years. In the eighth year the loan resets as an ARM. Just be sure you know what the margin, life cap and periodic caps will be beginning in the eighth year to avoid surprises. Use those seven years to reduce debit and increase your income in preparation for what is likely to be a much higher rate than your starting rate.”

Sounds convincing, right? But don’t’ rush to your lender and ask to be approved of this hybrid loan. You need to learn the pros and cons of it or you’ll soon realize that 7 isn’t a lucky number.

More commonly known as the 30/7 loan, it serves as a security for borrowers who need lower interest rates of the adjustable rate mortgages. It has a fixed rate for seven years and an adjustable rate after hence, the name. What’s good about it is that a borrower can have the option of converting it to a fixed rate loan after seven years. The interest rates that will be used depend on the time of conversion.

If you encounter a loan that’s called 7/1 ARM, bear in mind that it’s still a Lucky 7 loan. The second digit (1) indicates the period between rate changes during the adjustable rate period.

This is advisable for people who intend to stay in their home for more than 10 years, if they do not expect using their home equity during the loan term and if they are comfortable with long-term interest rate fluctuations. The lower interest rate at the initial term of the loan attracts most borrowers. After all, the loan caters to those who can’t decide whether to settle for a fixed rate or an ARM.

But of course, there’s always a downside. How many people have already sought to modify their existing mortgages to fixed rate types these days? It seems Memelstein’s advice can only be more appropriate to those who’d like to take high risks and not mind paying higher monthly fees. That’s something hard to find these days. The Lucky 7 loan’s interest rate is actually higher than that of a standard ARM to compensate the lender for seven years of fixed payments. Those who are planning to take a 7-year balloon loan may also be surprised that the Lucky 7 loan is even more expensive.

Another disadvantage of this loan is the penalty fee that you’d have to pay once you refinance or sell your home before five years. Some borrowers are surprised by the high cost that they have to pay back. If you think about it, they have something to do with it in the first place. Borrowers need to clarify every item in the contract to avoid eventual disputes.

If you are looking for career progress or have plans of moving out of the house before seven years, then the Lucky 7 loan is ideal for you but do not rely on this basis alone. Use it as one factor in determining the best option that your financial status will be most compatible with. This is the main reason why most recipients of hybrid loans are in so much trouble today for they were caught unprepared by the potential for higher payments when interest rates increased.

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