What Is a Convertible Mortgage?

Selecting the right mortgage product isn't as exciting as finding your home, but getting the financial fit right is just as important as finding the perfect floor plan. Lenders change what products they offer and they limit what they offer to whom, based in part on the applicants' finances and credit scores.

Transformers of Home Finance

Convertible mortgages are the transformers of home finance. You start out with an adjustable-rate mortgage and then have the option to convert it to a fixed-rate loan. The mortgage product originated in 1983, at a time when home mortgage rates peaked in March of that year at over 17 percent. The Federal Home Loan Mortgage Corporation, or Freddie Mac, sponsored the new loan types in response to market uncertainties surrounding high mortgage rates, "The New York Times" states.

When Convertible Is the Way to Go

Select a convertible mortgage when interest rates are high, which makes home loans very expensive. Rather than opting for a fixed-rate loan that typically has higher interest rates, you can obtain an adjustable-rate mortgage, or ARM to benefit from the lower initial rates. When mortgage rates fall, you can essentially refinance without closing costs. You might decide on a convertible mortgage even when rates are low if you plan to sell before your variable-rate loan resets, but want a backup plan in case you don’t find a buyer. Convertible mortgages give you the option to "opt in" after a specified period to a fixed rate.

Switch When You Want

Convertible mortgages provide you flexibility and a certain amount of security. One advantage of convertible mortgages is that you can switch to a fixed-rate loan at a future date, even if housing prices fall. Refinancing is tricky during a housing downturn. Lenders might turn you down if lower home values increase your loan to value ratios over 80 percent. Loan to value ratios measure how much you owe compared to the market value of your house.

Conversions Aren't Free

Lenders charge a fee for converting your loan from a variable to a fixed-rate mortgage. The fees vary from one lender to the next, but converting isn’t fee-free. You typically only have one chance to convert. When the terms of the loan state that your converting window is between year three and year four of the mortgage, you must act then or keep the adjustable rate for the life of the loan. If interest rates rise during that time, or don’t fall far enough to make a fixed-rate product affordable, you'll lose out.