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Convertible ARM Mortgage: A Definition

5-Minute Read
Published on June 14, 2022
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When you’re in the market to buy or refinance a home, there are many loan options you’ll be trying to sort through. You may be familiar with a fixed-rate mortgage and maybe even an adjustable-rate mortgage (ARM), but what about a mortgage that combines the two? Let’s talk about the convertible ARM.

While Rocket Mortgage® doesn’t offer convertible ARMs, this article will help you evaluate your options.

Find out if an ARM is right for you.

See rates, requirements and beneifts.

Explore ARMs

What Is A Convertible ARM Loan?

A convertible ARM loan is an adjustable-rate mortgage that allows borrowers to convert to a fixed-rate mortgage after a specified period.

We’ll get into this more a little later on, but with interest rates rising, an ARM can be attractive to real estate investors looking to get mortgages in this market as they tend to have lower initial rates than a fixed-rate home loan. The downside of this type of mortgage is that the rate is lower because investors know it can adjust later on to reflect current market conditions.

The beauty of a convertible ARM is that it allows you to go from an ARM to fixed-rate mortgage. In this way, you can get the low initial rate associated with ARMs, but you have the option of rate certainty in the future.

How A Convertible ARM Loan Works

To understand a convertible ARM, it’s necessary to understand the mechanics of both adjustable- and fixed-rate mortgages. Before we go any further, let’s break down the differences here.

An ARM loan has a fixed interest rate for a number of years at the beginning of the loan term. This initial interest rate, sometimes referred to as a teaser rate because it’s lower than comparable interest rates you can get for fixed-rate loans, may last 5, 7 or 10 years. Once this period is over, the rate adjusts at intervals, often every 6 months or each year. The term is usually 30 years.

Fixed-rate loans have an interest rate that doesn’t change over the course of your mortgage. Your payment may change as a result of fluctuations in property taxes and homeowners insurance, but the amount you put toward your principal and interest doesn’t change.

Adjustable-rate loans may be confused with loans that feature a variable rate. However, variable rates change each time a payment is due. An adjustable-rate mortgage has a period when the rate is fixed at the beginning of the loan.

The key thing to understand about a convertible ARM is that you have a period of time in which you can switch to a fixed rate. Here’s how it works:

  • It begins as an adjustable-rate mortgage. If you don’t elect to convert the mortgage, it’ll adjust after the fixed-rate period expires.
  • If you do decide to convert to a fixed rate, you’ll have the option to do so for the first number of years (usually anywhere between 1 and 5, but it will be specified in your contract).
  • You typically have to pay a fee in order to lock in the interest rate, but you don’t have to pay for closing costs again.
  • When you convert to a fixed-rate mortgage, your contract will have language on exactly when and how the market rate is determined at the time of conversion.

The Eligibility Requirements For A Convertible Mortgage

Rocket Mortgage doesn’t offer convertible ARMs at this time. However, when you’re looking at this option, remember a few basic things that will help you get approved for any mortgage loan.

  • Keep an eye on your credit score. Your credit score helps determine whether you can be approved for a particular type of mortgage and it’s one of the key determinants of your interest rate. You can keep your score high by not taking out credit or loans you don’t need, keeping your credit utilization low and making your payments on time.
  • Maintain a low debt-to-income ratio (DTI). DTI is a comparison of your monthly debt payments to your income before taxes. This is one of the most important mortgage qualification factors because lenders use this to determine the monthly payment you can afford.
  • Save for a down payment. There’s usually a minimum down payment you need to purchase or an amount of equity that you need to refinance. But beyond that, the higher your down payment or equity, the less risk your loan poses for a mortgage lender, so you’ll get a better interest rate.

For specific qualifications applying to a convertible ARM, speak with your lender.

Find out if an ARM is right for you.

See rates, requirements and beneifts.

Explore ARMs

The Pros And Cons Of A Convertible ARM Loan

Every mortgage option has its benefits and drawbacks. Let’s run through them for convertible ARMs.

Pros

There are a few advantages:

  • Flexibility: You have the option of converting to a fixed-rate mortgage for the first several years of the loan without refinancing.
  • ARM conversion is less expensive: If you do decide to convert to a fixed rate, you won’t have to pay closing costs as you would if you needed to refinance.
  • Lower than fixed initial interest rate: Because the interest rate is adjustable before you convert it, it will be lower initially than fixed rates for the same term length. The reasoning is that investors don’t have to account for inflation as far in advance if they know the rate can adjust later.

Cons

While there are benefits, there are also downsides to convertible ARMs:

  • Unpredictable: Rates could go up or down. You just can’t know whether it makes sense to convert to a fixed-rate mortgage at any given time. It’s extremely hard to predict interest rate movements.
  • Your payment amount could increase: If you find yourself in a situation where the prime rate or other index that your ARM is tied to is rising, your monthly payment may go up and because fixed rates are higher it won’t make sense to do the conversion.
  • Rates typically higher than standard ARMs: Because there is the option to convert to a fixed rate for several years, rates are typically slightly higher than you would receive with a traditional ARM.
  • Conversion fee: There is usually a fee to convert from an ARM to a fixed rate. Be aware of this before moving forward.

Why Are Convertible Mortgages A Good Idea?

Speaking generally, the good thing about convertible ARMs is that they give you the flexibility to convert to a fixed-rate mortgage without having to go through a full approval for a refinance and pay closing costs again. The defining feature is the choice clients have on the front end of the mortgage.

When Should You Get A Convertible Mortgage?

The best time to get a convertible ARM is when you think rates will shortly fall. It doesn’t make sense to convert to a fixed rate when rates are higher. If, on the other hand, rates fall, that’s when you want to lock that rate in.

The problem is it all comes down to your best guess at some point. No one can predict which way interest rates are going to go with 100% certainty. There are real risks involved with being stuck with higher payments.

How To Get A Convertible ARM Mortgage

The process for getting a convertible ARM should be similar to getting any other mortgage except that it starts as an ARM, so you’ll be qualified a little differently. The amount you can qualify for is going to be based on the lifetime caps for the ARM.

Other than that, you’ll want to have income and asset documentation ready. Among others, it’s a good idea to have the following available:

  • W-2s
  • 1099s
  • Tax returns
  • Bank statements
  • Pay stubs

The Bottom Line: Weigh The Benefits And Risks Before Getting A Convertible Arm Loan

A convertible ARM can give you the flexibility to convert from an adjustable-rate to a fixed-rate mortgage. However, it’s important to be aware that there’s a cost to doing this and the ARM rate may be higher than you could get with a standard ARM. Additionally, it may not make sense to convert to a fixed rate if interest rates rise, so you’re really making a bet.

While Rocket Mortgage doesn’t offer convertible ARMs right now, we recommend speaking with a Home Loan Expert about all your mortgage options. You can get a mortgage approval started online. You can also give us a call at (833) 230-4553.

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Kevin

Kevin Graham

Kevin Graham is a Senior Blog Writer for Rocket Companies. He specializes in economics, mortgage qualification and personal finance topics. As someone with cerebral palsy spastic quadriplegia that requires the use of a wheelchair, he also takes on articles around modifying your home for physical challenges and smart home tech. Kevin has a BA in Journalism from Oakland University. Prior to joining Rocket Mortgage, he freelanced for various newspapers in the Metro Detroit area.