At What Cost and Rate

Have you found that elusive free lunch? Probably not. On occasion, the convertible option pays off. More often, its chrome dazzles more than its horsepower. Few borrowers ever exercise their option to convert. Here's why:

  • Higher interest rate. Most borrowers think they can convert at the market rate. Not true. If, for example, at the time of the conversion, fixed-rates have dropped to 7 percent, your converted fixed-rate would probably carry an interest rate premium of .25 to 1.0 percent— or a total rate of somewhere between 7.25 and 8.0 percent.
  • Conversion fee. Lenders will charge a conversion fee that may range from a low of $100 to as high as 1 percent of the outstanding balance on your loan.
  • Up-front cost. You also typically pay for the conversion privilege at the time you take out the ARM—chiefly through a higher starting interest rate or higher loan origination fees.
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