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Convertible ARMs
Convertible Arms
A Convertible Adjustable Rate Mortgage lives up to its name. It's an Adjustable Rate Mortgage that can be converted to a Fixed Rate Mortgage. Usually, however, there are restrictions placed on converting from an adjustable rate to a fixed rate. These restrictions can come in the form of a timeframe that the mortgage must be converted in or a fee associated with converting.
The benefits of a Convertible ARM as opposed to a Traditional Fixed Rate Mortgage or other forms of Adjustable Rate Mortgages are the low introductory interest rates and the reduced interest risk. In addition, there is a significant savings on closing costs, appraisals, title insurance and more that is normally associated with refinancing other forms of Adjustable Rate Mortgages. Interest rates on Convertible ARMs are low due to the borrower absorbing some of the interest risk on the loan. With a Traditional Fixed Rate Mortgage the lender absorbs all of the risk of rising interest rates, thereby having to charge the borrower a higher rate to mitigate this risk. However, the interest risk taken on by the borrower is alleviated a little more than other Adjustable Rate Mortgages because of the ability to convert it to a Fixed Rate Mortgage.
The only drawbacks of a Convertible ARM are that the conversion rate tends to be slightly higher than the prevailing fixed rate and there is usually a fee that must be paid in order to convert. This higher fixed rate than prevailing market rates is due to the lender having to assume interest risk for a mortgage they already have. It wouldn't make sense to assume interest risk for nothing. The fee associated with the actual conversion is minimal (usually 1% of the original loan) and is less costly than refinancing. However, the borrower must pay this fee to convert. If they can't afford to pay the fee during a conversion period they miss the opportunity and are stuck with a mortgage that potentially has rising interest rates.