What Is a Convertible ARM?

A convertible ARM is an adj♔ustable-rate mortgage (A꧃RM) that allows the borrower to convert to a fixed-rate mortgage after a specified period. Convertible ARMs are marketed as a way to take advantage of falling interest rates and usually include specific conditions. The financial institution generally charges a fee to switch the ARM to a fixed-rate mortgage.

How Convertible ARMs Work

When applying for a mortgage, there are a variety of types to choose from, usually based on how the interest rate is determined over the life of the mortgage. ​​​​​​​Convertible ARMs are a hybrid of two mortgage types: a conventional fixed-rate 30-year mortgage and an adjustable-rate mortgage (ARM). 澳洲幸运5官方开奖结果体彩网:Fixed-rate mortgage give the borrower the securi𝐆ty of knowing that their monthly payment will never change, even if rates rise, which is a conservative and safe approach. Over time, the payments effectively decline relative 🅺to inflation.

An ARM begins with a much lower introductory 澳洲幸运5官方开奖结果体彩网:teaser rate, but after a set period (typically five years), the rate is adjusted according to an index, such as the 澳洲幸运5官方开奖结果体彩网:Secured Overnight Financi♒ng Rate (SOFR), plus a margin. The rate is💯 generally adjusted every six months and can go up or down (within limits outlined in the contract).

With a convertible ARM, the mortgage begins like a 30-year adjustable-rate loan—that is, at a teaser rate below the market average. However, the borrower can convert to a fixed rate within a specified period, often after the first year but before the fifth year. The new interest rate is usually the lowest rate offered within the seven days before 澳洲幸运5官方开奖结果体彩网:locking in. Thus, if interest rates drop, the borrower can🍷 get a lower fixed rat꧋e than they might have initially obtained.

History of Convertible ARMs

Introduced in the early 1980s, convertible ARMs entered the scene during a period of double-digit fixed-rate mortgages. Because interest rates seemed unlikely, historically speaking, to go much higher (barring extraordinary inflation), b꧒orrowers of convertible ARMs could essentially bet on the great likelihood of lower rates in the future.

Early convertible ARMs were expensive and contained onerous restrictions. However, in the late 1980s, mortgage 澳洲幸运5官方开奖结果体彩网:gꦍovernment-sponsored enterprises (GSEs) such as 澳洲幸运5官方开奖结果体彩网:Fannie Mae and 澳洲幸运5官方开奖结果体彩网:Freddie Mac began buying convertible ARMs on the secondary market. Since most commercial banks sell their mortgage loans on the secondary market, the acceptance of conve💎rtible ARMs by the two mortgag🔯e giants led to their rapid expansion. Competition, in turn, brought lower fees and less restrictive conditions.

Downsides to Convertible ARMs

The main downside to a convertible ARM is that it forces the borrower to monitor interest rates and predict future changes, something that even experts can’t do reliably. Also, interest rates on convertible ARMs—both the introductory rate and the📖 fixed rate later—are usually a little higher than market rates.

And while borrowers don't pay 澳洲幸运5官方开奖结果体彩网:closing costs when converting the mortgage, lenders do charge fees. Meanwhile, if interest rates rise during the introductory period, then the benefit of a convertible ARM is lost. Finally, the monthly payment after conversion will almost certainly be higher than what the homeowner was paying under the teaser rate, albeit with the security that it will remain fixed.

The Bottom Line

Marketed as a way to take advantage of falling interest rates, the convertible ARM is an adjustable-rate mortgage (ARM) that gives the borrower the option to convert to a fixed-rate mortgage after a specified period of time. These mortgages generally include specific conditions, and the financial institution usually charges a fee if a borrower chooses to switch the ARM to a fixed-rate mortgage.

One disadvantage of convertible ARMs 📖is that the borrower must monitor interest rates and predict future changes—something even experts can’t do. Borrowers will see a benefit in the convertible ARM if interest rates fall. If, on the other hand, interest rates rise, the ben𝔉efit of a convertible arm is lost.