Convertible Adjustable-Rate Mortgage (ARM): Is It Right for You?

Lower initial monthly payments and interest rates during the first few years make adjustable-rate mortgages (ARMs) an appealing option for many homebuyers. But because no one can predict interest rate movement in the future, some borrowers worry about climbing rates after the initial fixed-rate period ends.

A convertible adjustable-rate mortgage (ARM) gives some borrowers the opportunity to start with an adjustable-rate mortgage while keeping the option to convert to a fixed interest rate later if the loan includes a conversion feature.

Although convertible ARMs are a niche loan product, in this guide, we'll explain how convertible ARMs work, who they may be a good fit for, and the benefits and drawbacks to consider before choosing this type of mortgage.

What Is a Convertible ARM?

A convertible adjustable-rate mortgage (ARM) is a type of adjustable-rate mortgage (ARM) that lets borrowers switch from an adjustable-rate to a fixed interest rate, as long as they meet the lender's eligibility requirements. Like other adjustable-rate mortgages (ARMs), this type of loan typically starts with a fixed-rate for an introductory period, which is usually five, seven, or 10 years, however, convertible ARMs are not a common mortgage product.

After the fixed-rate period ends, the interest rate may go up or down based on market conditions. However, some convertible ARMs include the option to lock in a fixed interest rate later. To do so, borrowers may need to pay a conversion fee and meet certain lender requirements.

Remember that not all convertible ARMs work the same way. The rules usually vary by lender and loan, including when you can convert, whether a fee applies, and who qualifies. So, if you're choosing a mortgage, it's important to carefully review the terms of any convertible ARM.

Convertible Mortgage vs. Adjustable-Rate Mortgage

Convertible adjustable-rate mortgages and traditional adjustable-rate mortgages share some similarities, but they also have some important differences.

Here are a few key differences:

How Does a Convertible ARM Work?

Generally speaking, convertible ARMs have two phases: an initial adjustable-rate period and the option to convert to a fixed interest rate if your loan allows.

Initial Phase

The first phase of a convertible ARM works much like a traditional adjustable-rate mortgage. Your loan begins with a fixed interest rate, meaning a fixed monthly mortgage payment that lasts for a set period. Once this period ends, the loan enters the adjustable-rate period, which lasts for the rest of the loan term. With a variable interest rate, your rate can vary over time based on market conditions. If your interest rate changes, your monthly mortgage payment may also adjust, increasing or decreasing depending on how the market moves.

Conversion Phase

If your loan includes the conversion feature, you may be able to switch to a fixed interest rate for the rest of the loan term. However, to exercise this option, you must meet your lender's eligibility requirements, which can include submitting a conversion request within a certain time frame, staying current on your mortgage payments, and meeting other eligibility criteria.

Conversion clause: The conversion clause explains when and how you can convert to a fixed interest rate. It outlines the rules for using the conversion feature, including any deadlines and the requirements you must meet.

• Conversion fee: Some lenders charge a conversion fee if you choose to convert your ARM to a fixed-rate loan.

Keep in mind that convertible ARMs are not widely available and that conversion rules and fees vary by lender and loan. Freedom Mortgage does not offer convertible ARMs. Before choosing a convertible ARM, make sure to carefully review the loan agreement so you understand when you can convert, whether a fee applies, and what other requirements you must meet.

Convertible Mortgage Rates

Convertible ARMs often begin with a lower interest rate than a comparable fixed-rate mortgage. After the introductory fixed-rate period ends, the interest rate may adjust at scheduled intervals based on market conditions unless you choose to convert to a fixed interest rate and meet your lender's requirements. Because rates vary, the exact interest rate you'll qualify for depends on several factors, including market conditions, your credit profile, your down payment, and your lender.

Pros and Cons of Convertible Mortgages

Although convertible ARMs may offer a little bit more flexibility than other types of mortgages, they also come with tradeoffs that are worth considering.

Potential Benefits of a Convertible ARM

• Lower initial interest rates: One of the attractive features of a convertible ARM is its lower initial interest rate, which is often lower than the rate offered on a comparable fixed-rate mortgage. This may reduce borrowing costs during the fixed-rate period.
• Lower initial monthly payments: Because the initial interest rate is often lower, borrowers may also have lower monthly mortgage payments during the first few years of the loan.
• Option to convert to a fixed-rate mortgage: Some convertible ARMs give borrowers the option to switch to a fixed-rate later in the loan. This may provide more predictable monthly mortgage payments if you decide you no longer want an adjustable interest rate.
• Potential protection from future ARM rate adjustments: If you choose to convert your loan to a fixed interest rate, future interest rate adjustments will no longer affect your monthly mortgage payment, resulting in more predictable payments.
• May avoid refinancing if conversion is available: With some convertible ARMs, borrowers can switch to a fixed-rate loan without applying for a new mortgage. Depending on the lender and loan terms, this may help you save time and reduce some of the costs associated with refinancing.

Potential Drawbacks of a Convertible ARM

• Future interest rate adjustments and potentially higher payments: If you don't convert your loan, your interest rate will continue to adjust based on market conditions. If rates rise, your monthly mortgage payment may also increase.
• Conversion eligibility restrictions: Even if you choose a convertible ARM, it doesn't mean you automatically qualify. You'll still need to meet your lender's eligibility requirements before you can use the conversion feature.
• Possible conversion fee: Although not every lender charges one, some convertible ARMs include a conversion fee when borrowers choose to switch to a fixed-rate loan. Fee amounts usually vary from lender to lender.
• Not all borrowers benefit from converting: Interest rates can change frequently, so the timing of a conversion matters. If rates have already gone up, switching to a fixed interest rate may be less advantageous.
• Limited time: The convertible feature of the ARM is commonly restricted to a limited period of time, often the first couple of years of the loan.

The right mortgage depends on many factors, including your financial goals, budget, how long you plan to stay in your home, and how comfortable you are with changing monthly payments. Although Freedom Mortgage does not offer convertible ARMs, if you're considering a convertible ARM, talking with your lender can help you understand your options and choose the loan that best fits your needs.

Why Homeowners Choose a Convertible ARM

Borrowers choose convertible ARMs for often the same reasons as traditional ARMs, such as:

• Lower introductory monthly payments: For some borrowers, especially first-time homebuyers, a lower initial interest rate may result in lower monthly payments during the early years of the loan, making homeownership more affordable.
• Flexibility if interest rates change: No one can truly predict where interest rates will go in the future. Convertible ARMs give you the opportunity to lock in a fixed rate, usually within a defined period of time, which may provide more consistent monthly payments for the remainder of your loan term.
• Short-term homeownership plans: If you plan to sell or refinance your home before the introductory period ends, you may be able to benefit from the lower initial interest rate without experiencing future interest rate adjustments.
• Changing financial circumstances: Your financial situation may look different a few years from now than it does today. If your income, expenses, or long-term goals change, having the option to convert to a fixed-rate mortgage may be a better fit for your financial needs.

Can You Switch from a Convertible Loan to a Fixed-Rate Loan?

Yes, as long as your loan includes a conversion feature. Some convertible ARMs let eligible borrowers switch to a fixed-rate mortgage without refinancing, while others may require you to refinance to make the change.

Because every loan is different, be sure to review the conversion deadlines, fees, and eligibility requirements before deciding whether a convertible ARM is right for you.

Converting vs. Refinancing Your Mortgage

After learning how convertible ARMs work, you may be wondering how converting your mortgage compares with refinancing an ARM loan. Although both refinancing and converting can help you move from an adjustable interest rate to a fixed interest rate, the process is different.

Final Thoughts: When a Convertible ARM Makes Sense

Every homebuyer has a different situation, which means there's no one-size-fits-all mortgage. A convertible ARM may make sense if you're looking for flexibility today while keeping additional options open in the future. Ultimately, the right choice depends on your financial goals, how long you plan to stay in your home, and the terms of the loan.

Taking the time to compare different mortgage options can help you better understand your choices and determine which loan best fits your long-term homeownership plans. When you're ready, explore Freedom Mortgage's mortgage options or get prequalified to see what you may qualify for.