What Is a Convertible ARM
A convertible ARM is an adjustable-rate mortgage that includes a provision allowing you to convert it to a fixed-rate loan. This conversion happens through a legal modification agreement that changes your loan terms permanently.
The conversion option protects you from rising interest rates. If rates climb after you get your ARM, you can lock in a fixed rate instead of continuing with adjustable payments. Once converted, your loan becomes a standard fixed-rate mortgage with level monthly payments.
Say you took out a 5/1 ARM in 2020 at 3.5%. Two years later, when rates hit 6%, you could exercise your conversion option to lock in a fixed rate rather than face potential rate increases when your adjustment period begins.
How the Conversion Process Works
Converting your ARM requires executing a loan modification agreement. This legal document changes your original loan terms from adjustable to fixed-rate. The lender must record this modification if required by local law to preserve the mortgage's lien position.
You cannot convert immediately after closing. Fannie Mae requires the ARM to be at least 12 months old before conversion. This waiting period ensures you have established a payment history on the original loan terms.
The converted mortgage must provide for a fixed interest rate, level monthly payments, and full amortization within the original loan term. If your original ARM was a 30-year loan, the converted fixed-rate version must still pay off within that same 30-year period.
Qualifying for a Converted ARM
When you convert your ARM, the lender has flexibility in how they qualify you for the new fixed-rate terms. They can use your original loan file documentation if you can qualify under either of two scenarios.
First, you can qualify based on the new fixed rate after conversion using current Fannie Mae underwriting guidelines. Second, you can qualify using the original ARM rate and the underwriting guidelines that were in effect when you first got the loan.
If neither approach works, the lender must fully requalify you. This means getting a new loan application, fresh credit reports, updated employment and income verification, and evaluating your ability to pay based on the converted fixed rate and current underwriting standards.
Consider a borrower whose income dropped since getting their ARM. They might not qualify at today's fixed rate with current guidelines, but they could still qualify using their original ARM rate and the older, potentially more lenient underwriting standards from when they first applied.
Rate and Payment Increase Limits
Fannie Mae caps how much your rate and payments can have increased before conversion. If you qualify using your original ARM terms and guidelines, total interest rate increases cannot exceed 2% from your original rate.
Payment increases face a 15% limit under the same qualification method. These limits include all scheduled ARM adjustments plus any buydown plan increases that occurred after your loan originated.
Here's an example: Your original ARM rate was 4%. If rates adjusted upward and you now pay 6.5%, that's a 2.5% increase. This exceeds the 2% limit, so you cannot qualify using original terms and must meet current underwriting standards instead.
Required Documentation
The lender must provide specific documents when delivering a converted ARM to Fannie Mae. The primary requirement is a Loan Modification Agreement using Fannie Mae Form 3179 or a substantially equivalent document that includes an enforceable due-on-sale clause.
If local law requires recording the modification to preserve lien position, the lender must submit the recorded instrument. They must also obtain a title bring-down through the date of recordation to ensure the mortgage maintains its priority.
For loans removed from ARM mortgage-backed securities pools, lenders must identify the converted loan with Special Feature Code 036 when redelivering it to Fannie Mae as a whole loan.
Title Insurance Considerations
The conversion cannot impair your existing title insurance policy or any endorsements. If your original policy lacked the ARM endorsements currently required by Fannie Mae, the lender must indemnify Fannie Mae against any title issues.
This protection ensures that converting your ARM doesn't create gaps in title coverage that could affect the loan's security or Fannie Mae's interests in the property.
Negative Amortization Issues
If your ARM experienced negative amortization before conversion, special loan-to-value requirements apply. The LTV, CLTV, and HCLTV ratios must be satisfied through normal amortization, borrower contributions, or increased property value supported by a current appraisal.
Negative amortization occurs when your monthly payments don't cover the full interest due, causing your loan balance to grow. Before conversion, this increased balance must be addressed to meet Fannie Mae's LTV requirements.
Loan Limit Flexibility
Fannie Mae provides flexibility for converted ARMs regarding loan limits. If Fannie Mae's maximum loan limits decreased between when your ARM was originally securitized and when it's redelivered after conversion, your loan remains acceptable even if it exceeds current limits.
This recognizes that your loan met requirements when originally approved and that redelivery results from administrative requirements rather than a new loan transaction.
Common Complications
Income changes since your original ARM closing can complicate conversion. If your income dropped significantly, you might not qualify under current underwriting standards, forcing the lender to use original qualification methods if rate and payment increases stay within limits.
Credit issues that developed after your ARM closing can also create problems. While you might qualify using original documentation, any new derogatory credit events could require full requalification under current standards.
Property value changes affect qualification too. If your home lost value since closing, higher LTV ratios might prevent conversion approval, especially if your ARM experienced negative amortization.
References
For the official guidelines, see B2-1.4-03: Convertible ARMs in the Fannie Mae Selling Guide.
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Original Fannie Mae Guideline Text
B2-1.4-03, Convertible ARMs (02/23/2016)
General Information
Converted ARMs Removed from ARM MBS Pools
Borrower Requalification Considerations for Fixed-Rate Mortgages Converted from ARMs and Redelivered Under “Market Rate” Post-Conversion Options
Eligibility Requirements for Converted ARMs
Delivery Requirements and Security Instruments for ARMs Converted to Fixed-Rate Mortgages
Mortgage Documents for Fixed-Rate Conversion Option
General Information
Fannie Mae accepts delivery of fixed-rate mortgages that were converted from ARMs either by a legally executed modification agreement or under the provisions of the mortgage instrument.
Although the ARM does not have to have been originated on Fannie Mae uniform instruments or in accordance with Fannie Mae eligibility requirements for ARMs, the new fixed-rate mortgage that results from the conversion must meet Fannie Mae’s general eligibility and underwriting requirements for newly originated fixed-rate mortgages.
Converted ARMs Removed from ARM MBS Pools
This topic describes the circumstances under which a converted ARM that is removed from an ARM MBS pool as the result of its conversion to a fixed-rate mortgages may be redelivered to Fannie Mae.
If the mortgage is more than 12 months old at the time of the redelivery, and the lender specified a “market rate” post-conversion disposition option when the MBS pool was delivered to Fannie Mae, the mortgage must meet the same eligibility criteria as other converted ARMs (as discussed in “Eligibility Requirements for Converted ARMs” later in this topic).
If the lender specified a take-out post-conversion disposition option when the MBS pool was delivered to Fannie Mae, the lender does not need to requalify the borrower or verify that the mortgage satisfies Fannie Mae eligibility criteria.
Borrower Requalification Considerations for Fixed-Rate Mortgages Converted from ARMs and Redelivered Under “Market Rate” Post-Conversion Options
To qualify a borrower, lenders may use the original in-file documentation to evaluate the borrower’s financial ability, as long as the borrower is able to qualify for the mortgage based on either of the following:
The mortgage interest rate in effect following the conversion and Fannie Mae’s current underwriting guidelines for a conventional fixed-rate mortgage, or
The mortgage interest rate in effect for the ARM when it was originated and the underwriting guidelines Fannie Mae used for ARMs at that time.
If the lender is unable to qualify a borrower under the previous options, the lender must requalify the borrower under Fannie Mae’s standard guidelines, including
obtaining a new loan application,
obtaining up-to-date credit reports,
obtaining new employment and income verifications using the acceptable documentation,
evaluating the borrower’s financial ability based on
the mortgage interest rate in effect for the converted mortgage, and
Fannie Mae’s current underwriting guidelines for a conventional fixed-rate mortgage.
Eligibility Requirements for Converted ARMs
The following specific eligibility requirements apply to converted ARMs that are delivered as either whole loans or MBS pool deliveries under the “market rate” post-conversion disposition option that were removed from an ARM MBS pool as the result of the conversion:
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Requirements
The ARM must have been at least 12 months old when the conversion occurred.
The converted mortgage must meet all of the eligibility criteria specified for mortgages that are more than one year old, unless Fannie Mae has specified that those criteria do not apply.
The mortgage loan must be current at the time of delivery.
The total of all interest rate increases or payment adjustments (including any combination of scheduled ARM interest rate changes and the increases scheduled under an interest rate buydown plan) that occurred after the ARM was originated must not have exceeded 2% (for the interest rate adjustment) or 15% (for the payment adjustment) if the lender qualifies the borrower on the basis of the mortgage interest rate that was in effect for the ARM when it was originated and the ARM underwriting guidelines Fannie Mae used at that time.
The modified mortgage must provide for a fixed-interest rate, level monthly payments, and amortization within the term of the original mortgage.
The title insurance policy or any endorsements to it are not impaired because of the option to convert to a fixed-rate mortgage or the actual conversion.
If the original title policy did not include the ARM endorsements currently required, the lender must indemnify Fannie Mae (as described in
if Fannie Mae’s loan limits decreased between the time Fannie Mae initially securitized the ARM and the time the converted mortgage is redelivered to Fannie Mae after it is removed from the pool, the mortgage will still be acceptable to Fannie Mae even if the original mortgage balance exceeds the maximum mortgage amount that is in effect at the time of the redelivery.
BACKGROUND
This recognizes and acknowledges, respectively, the fact that
the loan satisfied Fannie Mae requirements when it was securitized, and
the redelivery is a function of an administrative requirement Fannie Mae imposed for mortgage-backed security transactions, rather than the delivery of a different mortgage.
Standard ARM Plan Matrix.
If the ARM had negatively amortized, the LTV ratio (and the CLTV ratio and the HCLTV ratio) requirement must be satisfied as a result of
Subsequent normal amortization
The application of funds contributed by the borrower, or
An increase in the value of the property.
Note: Increase in property value must be supported by a current appraisal.
Delivery Requirements and Security Instruments for ARMs Converted to Fixed-Rate Mortgages
Lenders must identify each converted ARM that was repurchased from an MBS pool because the conversion to fixed-rate option was exercised and subsequently redelivered to Fannie Mae as a whole loan delivery of a fixed-rate mortgage with SFC 036.
Lenders must include in the delivery package a Loan Modification Agreement ( Form 3179 ) as evidence of the conversion to a fixed-rate mortgage.
Note: A different (but substantially equivalent) modification agreement is also acceptable, as long as it includes an enforceable due-on-sale clause.
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Modification Agreement Requirements
Lenders must determine whether a modification agreement has to be recorded in each particular jurisdiction in order to preserve the lien position of the mortgage.
If recordation is required, lenders must submit the recorded instrument when it delivers the mortgage for purchase or securitization.
Lenders must obtain a title bring-down through the date of the recordation.
Mortgage Documents for Fixed-Rate Conversion Option
Execution of Fannie Mae’s standard riders or addenda that provide the terms for conversion to a fixed-rate mortgage or any other conversion option instrument is not required if:
a convertibility provision was included in the adjustable-rate note, or
the lender previously agreed to a conversion modification despite the fact that the loan documents did not give the borrower an option to convert. In this instance, lenders must provide a modification agreement to document the conversion and obtain a title bring-down through the date of the recordation.
See Riders & Addenda for current standard riders or addenda.
