You may be familiar with the advantages of closed fixed-rate mortgages, which offer predictability in terms of payments. However, there is another option that may be worth considering: a convertible mortgage. This type of mortgage offers several benefits that may make it a worthwhile choice for many homeowners. So, what is a convertible mortgage and why should you make it an option?
What Is A Convertible Mortgage?
A convertible mortgage offers the option to convert to a different mortgage with varying terms. These mortgages typically have a 6-month term and offer either a fixed or variable interest rate.
Borrowers are able to convert their mortgage to a longer-term closed mortgage at any time without incurring prepayment penalties. Ultimately, convertible mortgages provide a temporary solution that can be switched to a longer-term mortgage when the borrower’s needs change.
How Does It Work?
During the 6-month term of the convertible mortgage, if interest rates decrease, the borrower can choose to convert their mortgage to a fixed-rate closed mortgage. This allows them to lock in the lower interest rate for a longer term. It’s important to note that the conversion rate is determined at the time of conversion. Not when the borrower initially entered into their convertible mortgage term.
If interest rates do not decrease during the initial six-month term of a convertible mortgage, the borrower is not required to convert their mortgage. Instead, they can simply renew the mortgage for another convertible term. This provides the borrower with another six-month period to decide whether to convert or renew their mortgage again.
The Benefits
- Flexibility. Convertible mortgages provide borrowers with the flexibility to choose whether to convert their loan or renew it at the end of the initial term.
- Potentially lower down payment requirements. Some lenders may offer convertible mortgages which allows borrowers to make a down payment of less than 20%.
- The ability to save money. If interest rates decrease during the initial term of a convertible mortgage, the borrower can save money by converting to a fixed-rate mortgage with a lower interest rate.
- Avoid penalties. Many traditional mortgages come with penalties for paying off the loan early or breaking the mortgage before the end of the term. Convertible mortgages do not have these penalties, providing borrowers with additional flexibility and freedom.
The Potential Drawbacks
- The initial interest rate on a convertible mortgage may be higher than the rate on a fixed-rate mortgage, so you may end up paying more in interest if rates do not decrease during the initial term.
- If you choose to convert your mortgage to a fixed-rate loan, you may be limited to the available mortgage terms offered by the lender, which may not be the best option for your financial goals.
- Convertible mortgages may have stricter eligibility requirements and may not be available to all borrowers.
- It can be difficult to predict future interest rates, so there is always the risk that you may not be able to lock in a lower rate by converting your mortgage.
If you are unsure about whether to convert your mortgage, it may be helpful to speak with a financial expert to determine the best course of action for your unique situation.
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