What is a Convertible Mortgage?
What You Should Know
- Convertible mortgages allow you to switch to a longer-term closed mortgage without having to pay prepayment penalties.
- They usually have a fixed interest rate for a 6-month term that can be renewed.
- This gives borrowers the flexibility to switch mortgage terms if they feel that rates will decrease within the next 6 months, or if they are undecided about what mortgage to get.
A convertible mortgage is a type of mortgage that allows the borrower to convert their mortgage into a new mortgage with different terms. In Canada, convertible mortgages are usually offered in 6-month terms with a fixed or variable interest rate. You can convert your mortgage to a longer-term closed mortgage at any time without having to pay mortgage prepayment penalties. In short, convertible mortgages are a temporary mortgage solution that can be converted into a longer-term mortgage when your needs change.
Convertible Mortgage Lenders
Canada’s major banks all offer convertible mortgages with a 6-month term. This includes RBC, TD, Scotiabank, BMO, and CIBC. Some credit unions in Canada also offer convertible mortgages, such as DUCA Credit Union in Ontario.
How Do Convertible Mortgages Work?
Convertible mortgages act just like a regular mortgage, with the only difference being that you can change your mortgage term to a longer term length at any time. Some convertible mortgage lenders offer them with CMHC mortgage insurance as well, which means you can make a down payment of less than 20%.
Convertible mortgages usually have a term length of six months. If you see that mortgage rates are decreasing within these six months, you can convert your convertible mortgage to a fixed-rate closed mortgage to lock-in that lower interest rate for a longer term. The rate offered is the rate at the time of conversion, not at the time when you initially entered into your convertible mortgage term.
If rates do not decrease, you’re not forced to convert your mortgage. Instead, you can always renew your mortgage at the end of the six-month term for another convertible mortgage term. You then have another six months to convert, or to renew again at the end of the term.
One thing to note is that convertible mortgage rates are often higher than other term lengths. You wouldn’t want to keep having a convertible mortgage for a long period of time, as mortgage interest costs can quickly add up. Mortgage renewals also require the approval of your convertible mortgage lender, which isn’t guaranteed.
Open, Convertible, and Closed: What Are They For?
| Open | Convertible | Closed |
|---|---|---|
| Prepayment Flexibility | Interest Rate Term Flexibility | Lowest Interest Rate |
Convertible Mortgage Prepayments and Restrictions
When comparing closed vs open mortgages, closed mortgages come with prepayment penalties if you break your mortgage before the end of your term. On the other hand, open mortgages do not have prepayment penalties. Convertible mortgages act like an open mortgage where you can break your mortgage at any time to switch terms without penalties.
However, convertible mortgages feature the same restrictions that closed mortgages have when it comes to prepayments during your term. The same annual prepayment limits apply to convertible mortgages as they do to closed mortgages.
The specific limit depends on your mortgage lender and on your mortgage contract. It usually ranges from 10% to 15% of the original mortgage principal amount each year. This means you cannot fully pay-off your convertible mortgage during the term without incurring penalties. In spite of that, you can always wait until the end of your convertible mortgage term, which is usually just six months.
After you convert a convertible mortgage to a fixed-rate closed mortgage, you can’t switch or refinance it without paying penalties or waiting until the end of the new mortgage term. You can only convert out of a convertible mortgage once!
Convertible Variable Rate Mortgages
Convertible mortgages can also come with a variable interest rate. In the first half of 2022, over 40% of all new variable rate mortgages were closed convertible variable rate mortgages. In December 2021, convertible mortgages made up over 50% of new variable rate mortgages in Canada! While convertible mortgages are not as common for fixed rate mortgages, they do make up a significant proportion of variable rate mortgages.
Convertible Mortgage
(% of Variable Rate Mortgages)
| Total Mortgage Volume | % of Variable Rate Mortgages | |
|---|---|---|
| Convertible Variable | $60.4 Billion | 44.7% |
| Non-Convertible Variable | $74.8 Billion | 55.3% |
Source: Bank of Canada, average for January 2022 - July 2022
Example of a Convertible Mortgage
Let’s say that you think interest rates will fall in the near future, but you would still like to lock-in your rate with a fixed-rate mortgage in the future. As an example, suppose that your lender is currently offering a 6-month fixed convertible mortgage rate of 5%, and a 5-year fixed rate of 6%. You choose the convertible mortgage. Within six months, the 5-year fixed rate has now fallen to 5%. You can switch over to this lower 5-year fixed mortgage rate without penalties.
What happens if interest rates aren’t favourable? If mortgage rates have stayed the same or increased, you can choose to renew your convertible mortgage for another 6-month term. You could wait to see if rates will decrease again, however, there is no guarantee that this would happen. There’s also no guarantee that you would be approved for a mortgage renewal, which might be the case if your financial situation has significantly changed.
Summary
The main advantage of a convertible mortgage is the flexibility it offers. Convertible mortgages are a good choice if you're not sure how long you'll stay in your home. You can choose a shorter-term mortgage now and convert to a longer-term mortgage later when you're ready to commit to staying put for a while. It’s also a temporary mortgage solution that allows you to wait in case interest rates fall in the near future.