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Introduction to Convertible ARM
If you are looking to buy a home, mostly you would require finance to buy that home.
There are multiple options that an individual can choose from to get a mortgage like conventional mortgages, VA loans, USDA loans, and FHA loans.
However, there is one other option in the market called a convertible ARM. In this post, we will learn what does convertible arm means and how it works.
What is a Convertible ARM?
A Convertible ARM or a Convertible Mortgage is a loan that allows the borrower to change the loan from being adjustable rate to a fixed rate after a specific time.
The convertible mortgage is based on specific parameter requirements and not all lenders will be able to provide such options.
How does a Convertible Arm Work?
The borrower would be initially paying a lower interest rate compared to the market while in the adjustable phase of the loan.
Your interest rates will be variable in the initial period of the loan just like any other variable rate mortgage.
Once the lender converts the loan into a fixed-rate mortgage, the interest rate is usually adjusted to a higher rate compared to the market index at the time of conversion.
In case, the index rate is lower than what it was during the adjustable-rate phase, the borrower might be able to get a lower interest rate during the fixed rate.
The new interest rate will be based on the lowest interest rate within a week from the day when you finally decide to convert.
The loan is converted by the lender after a specific period, usually, between 1-5 years.
When converting an adjustable-rate to a fixed-rate mortgage, the lender might not charge a closing cost that is usually charged when you refinance or finance a loan for the first time.
However, there are some fees associated with the convertible arm. The charge of the convertible arm may vary from lender to lender.
Pros and Cons of a Convertible Mortgage
Just like any other mortgage, a convertible loan knowing about the pros and cons of a convertible mortgage can help you make an informed decision.
Pros:
The best advantage of a convertible ARM is that you would be getting the lowest interest rate on the mortgage compared to any other loan based on the current mortgage rate index.
Let’s say that the current mortgage interest rate is 4%. If you know for a fact that the interest rates are going to dip in the coming few years, instead of waiting for the low fixed rate to come you might want to get a convertible mortgage and you can buy a house for less than 4%.
After a few years let’s say after 4-5 years, once the rates are lower like 2.5%, you can convert the mortgage to a fixed rate and get a lower interest rate than what you might have got in the beginning (4%).
The ARM rates when you initially get it are lower than the market index, for example, instead of 4% you might be able to get 3.5% or 3.25%.
The convertible ARM would also help you save huge closing costs of refinancing in the future as the charges for a convertible mortgage are lower than the cost of refinancing.
Cons:
The ARMs were introduced in a market where interest rates were very high showed a potential dip in the future.
Hence, many people were able to take advantage of it. However, the mortgage market is extremely unpredictable.
If you lock into a convertible ARM loan anticipating that the interest rates will drop after a few years, and the interest rates increase, you would end up converting the interest rate which is a lot higher than what you might have paid if you would have got a fixed-rate mortgage to begin with.
Conclusion
Getting a convertible ARM loan is very risky. Even many experts are not able to predict the mortgage market to its full potential.
You do get benefits initially when you lock into one, however, to extend the benefit of the convertible mortgage, you need to be very sure about the mortgage market and only then think of getting one.
Your home is much of a bigger risk in case you end up in a situation where you might end up paying high monthly payments.
If you are a person who is ready to take the risk and are sure about the market movement, the convertible Arm could be the best option.
