A conversion option allows you to convert an ARM to a fixed rate mortgage. You will likely pay a higher rate or more points to have this option.
More On Conversion Option
An ARM has a lower initial interest rate than a fixed mortgage. However, it only keeps this initial rate for a certain amount of time, depending on what type of ARM you have. With a 1 year ARM, the interest rate begins to change after the first year. The interest rate of an ARM then goes up or down every year for the term of the loan. Even though there is a rate adjustment cap that limits the size of the initial rate adjustment and another cap that limits the size of subsequent rate adjustments, you still run the risk that interest rates can go up dramatically, causing your mortgage payment to sharply increase.
When applying for an ARM, see if the lender will let you get a conversion option. Then, if rates begin to rise and you are worried they are rising too much, you can convert your ARM to a fixed rate mortgage. However, despite this security, there can be financial costs involved. For instance, if you get an ARM with a conversion option, your ARM may have a higher interest rate than is typical for ARMs. Also, your lender may charge you a fee to convert your ARM to a fixed rate mortgage.
Despite the costs, it may still be worth it to you to have a conversion option with your ARM. If it appears that interest rates are going to rise sharply, the conversion option can give you some security. However, some other options to consider are either going ahead and getting a fixed rate mortgage or possibly getting a hybrid ARM. The hybrid ARM acts as an ARM for a specific time period, such as five years or ten years, but then becomes a fixed rate mortgage. Talk to your lender about which gives you the best interest rate before getting your loan.