The existence of a conversion option in a mortgage contract agreement allows the borrower to convert the loan to another during a stipulated period of time.
The conversion option comes with a date in which it will be active, and expire once the date passes.
They can be structured in any of the following ways:
- ARM to ARM
- ARM to FRM
- FRM to FRM
- FRM to ARM
Should a borrow choose to exercise the option, he would usually be able to choose from the current home loans that the lender offers for that specific type of property.
For example a borrower on a variable rate loan of might face an interest rate of 8% due to a spiking interbank rate. Moving to a current fixed rate loan at 7.5 % would seem like a wise decision.
However, lenders usually only allow the option to be exercised once during the life of the mortgage.
This means that if it has already been used, a borrower will not be able to convert the loan again even if the loan is still within the period of an active option.
The main advantages of having a conversion option is that it offers borrowers a choice of changing their decisions should they suffer a bout of buyers remorse in future.
This can be a great selling point for loan officers to convince borrowers and give them better peace of mind, especially when they are first time home buyers.
A second benefit is that by converting to another loan, the borrower is essentially refinancing the current loan with the current lender.
The difference being that there will be no closing costs.
If you are on the verge of signing up for a home loan and it does not have a conversion option, ask if it can be included.
Even though the odds of exercising it is not high, it can be a lifesaver should a situation arise in future that makes it invaluable.