Definition - What does Convertible ARM mean?
An adjustable-rate mortgage (ARM) is a mortgage loan with an interest rate that periodically adjusts to the rate of the index in which it is tied (e.g. the 12-month Treasury Average Index, Bank Bill Swap Rate, Constant Maturity Treasury, etc.).
Unfortunately, with an ARM, the rate usually rises, which causes the mortgage costs for the mortgage holder to increase, assuming that they choose not to refinance prior to the maturity of the ARM. For this reason, many homeowners have decided to avoid traditional adjustable-rate mortgages.
Another option for homeowners who want to protect themselves against market uncertainty, however, is a convertible ARM, which is a specific type of adjustable-rate mortgage. Created in 1983, a convertible ARM allows homeowners to initially use an adjustable-rate mortgage to finance a home purchase but then convert it to a fixed-rate loan at a later date. This is an option that provides both security and flexibility for the home buyer.
Justipedia explains Convertible ARM
For example, a homeowner may be allowed to convert their mortgage to a fixed-rate loan even if the value of their home has decreased. Homeowners may also receive a lower interest rate when initiating the loan, and unlike a standard adjustable-rate mortgage, the convertible ARM allows the homeowner the flexibility to convert to the fixed rate. Additionally, a convertible ARM allows for a lower monthly payment, at least for a specific period of time, allowing homeowners to save money on housing costs.
Although convertible adjustable-rate mortgages do offer many benefits for home buyers, they are not always the best option. For example, while a convertible ARM allows homeowners the option to convert to a fixed-rate mortgage, the conversion period may be limited per the terms of the loan. Contractually, some homeowners may also only have one to four years to convert to a fixed-rate mortgage, and during this period, the rates may or may not be low enough to warrant a change. Additionally, although there are no closing costs to refinance the loan to a fixed rate, there are fees associated with the switch.