What is a Rate-Improvement Mortgage

A Rate-Improvement Mortgage is a variation of a fixed-rate mortgage contract, which includes a clause permitting a borrower a one-time option to reduce their home loan interest rate when interest rates drop below the initially-contracted rate.

BREAKING DOWN Rate-Improvement Mortgage

A Rate-Improvement Mortgage is a type of fixed-rate mortgage which includes a clause entitling the borrower to reduce the interest rate on their mortgage one time, usually early in the life of the mortgage. This option is intended to be exercised when interest rates fall below the initially-contracted interest rate, and the lender will typically charge a fee for a borrower to exercise this option.

This type of mortgage can be attractive to borrowers who, for one reason or another, are purchasing property during at time of higher-than-average interest rates. Even with the associated fees, exercising the rate improvement option can be attractive way to reduce the interest rate on a home loan while avoiding the costs of refinancing the loan. Additionally, savvy borrowers who pay close attention to interest rate fluctuations may be able to take advantage of exercising a rate improvement clause at a time of lowered interest rates.

As with all financial instruments, it is recommended that all borrowers pay close attention to the terms and conditions included in the contracts to be aware of all associated fees and restrictions. Lenders offering a rate-improvement option in a mortgage contract will limit their risk by setting fees to cover anticipated costs and losses when the option is exercised.

Rate-Improvement Mortgages vs. Refinancing

A rate-improvement option is made available as part of the contract in a fixed-rate mortgage.

The fixed-rate mortgage became a primary financial instrument in the U.S. following the great depression. The U.S. Federal Housing Administration was established in 1934, and was responsible for creating and popularizing the 30-year mortgage. Over time, fixed-rate mortgages in the U.S. are offered in a variety of time structures, although the most popular terms for home loans are 15-year mortgages and 30-year mortgages. Today, the U.S. remains one of the only nations in the world which offers fixed-rate mortgages.  

While fixed-rate mortgages tend to be more expensive overall than adjustable-rate mortgages, they are not at the mercy of changing interest rates and the interest rate remains steady over the lifetime of the loan. The advantage of the rate-improvement mortgage allows a borrower to enjoy the benefits of a lowered interest rate without fully refinancing the loan, and attracting associated refinancing fees and paperwork.