How Does a Convertible Mortgage Work?

The Convertible Mortgage is one of the many options available to you, helping you to make home ownership as affordable as possible. This mortgage product gives you the best of both worlds – an adjustable rate in the beginning of the term with the option to convert to a fixed rate in the future.

How does the Convertible Mortgage Work?

The Convertible Mortgage begins like a standard ARM program. You secure an introductory rate for a specified period with the rate adjusting down the road. For example, a 3/1 ARM has a fixed interest rate for the first 3 years; after that point, the rate can adjust annually based on the economic indices the rate is based on.

Where this mortgage program differs, however, is the option you have to convert the mortgage into a fixed rate during a specified period. You do not have to opt to transfer the mortgage into a fixed rate, but you do have the option. Until you lock in that fixed rate, the mortgage remains an adjustable rate mortgage with the rate adjusting annually or on the predetermined periods.

If you decide to convert to a fixed rate, you do so during the designated time at which point you might have to pay a conversion fee. From that point on, you have a fixed rate loan – the interest rate will not adjust.

What are the Benefits of the Convertible Mortgage?

There are many benefits to this program, but the most obvious is the ability to lock in a lower interest rate than you received when you purchased the home. The program began in 1983 when interest rates were very high. At that point, home ownership was very expensive and the housing market suffered. With the Convertible Loan option, homebuyers had the opportunity to lock in a lower interest rate when rates fell.

With the option to convert your interest rate, you have the opportunity to save a great deal of money because you do not have to refinance. Typically, if you have an ARM, you have to refinance into a fixed rate loan if rates get too high or you wish to have more stability. This means that you have to pay closing costs as well as qualify for the new mortgage. You have to provide:

  • Income documents
  • Credit scores
  • Employment information
  • Valuation of your home

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If one of these factors renders you ineligible for the new loan, you are stuck with the ARM. The convertible program does not require you to refinance; you automatically qualify for the lower rate as long as you secure it during the designated period. There are no qualifying factors preventing you from taking advantage of the lower interest rate!

Another great advantage is the ability to lower your interest rate no matter what the value of your house does in the future. We all know that the housing market is volatile and unpredictable. If the value of your house drops in the future, it could make it difficult to refinance, especially if you are upside down on your mortgage. This could leave you stuck with a higher adjustable interest rate that you cannot afford. The Convertible Mortgage gives you the option to lock in that low fixed rate regardless of what the value of your home is at any given time, enabling you to save money and take advantage of the new, lower rates.

Short-Term Home Ownership

One of the largest groups of people that benefit from this mortgage program is those that plan on moving in the near future. If when you purchase the home, you know that you will move in the next 3 to 5 years, you can take advantage of the low introductory rate the ARM offers you. If you move before the rate adjusts, you saved money in the long run.

What happens if you do not move as intended and are in the home after the adjustment period? You have the “insurance” policy of the Convertible Loan. You do not have to settle for the adjusted rate or worry about refinancing; you have the option to convert your mortgage to a fixed rate if you think you will stay in the home for a longer period.

What does It Cost?

As with most things in the mortgage industry, there might be a cost to use your convertible option. This cost is called a conversion fee and is significantly lower than what it would cost you to refinance if you qualified. You should know ahead of time how much the conversion costs, though. Before you close on the Convertible Mortgage, you could always talk to the lender to inquire about the cost of converting the mortgage. Make sure you also read the fine print on your closing documents to ensure that you understand the full implications of the conversion.

Understanding the Conversion Window

Another factor that you must understand before you close on the Convertible Mortgage is when your conversion window occurs. Every loan is different as every lender has different programs they offer. It is important to talk to the lender and read your loan documents carefully so that you know when the window occurs. Typically, you have a one year period to take advantage of the locked-in fixed rate. If you go beyond that point, you are stuck with the ARM or you must refinance in order to get a fixed rate.

The Convertible Loan offers you many benefits, especially if rates are exceptionally high at the time that you close on your home. Think of your future plans and decide what will work for you. If you need a back-up plan in the event that you do not move as planned or you know you want a lower introductory rate now, but do not want the volatility of an adjustable mortgage down the road, this mortgage program could be the perfect choice for you.

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Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.

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