Rate-Improvement Mortgage

What Is a Rate-Improvement Mortgage?

A rate-improvement mortgage is a variation of a fixed-rate mortgage contract. It 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. This type of mortgage is a good option for property buyers if interest rates are high because it could save them from having to refinance when interest rates drop.

Key Takeaways:

  • A rate-improvement mortgage is a variation of a fixed-rate contract.
  • A rate-improvement mortgage permits a borrower a one-time option to reduce their home loan interest rates when the interest rates drop below the initially-contracted rate.
  • The lender will charge a fee for this option.
  • This option avoids the added cost and inconvenience of refinancing later, which might be required if interest rates are higher than average when the property is purchased.

Understanding a Rate-Improvement Mortgage

A rate-improvement mortgage is a type of fixed-rate mortgage that includes a clause entitling the borrower to reduce the interest rate on their mortgage once, usually early in the life of the mortgage. This option is 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 a time of higher than average interest rates. Even with the associated fees, exercising the rate improvement option can be an 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 can take advantage of exercising a rate improvement clause at a time of low 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, such as the 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 United States 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 United States have offered various of term structures, although the most popular terms for home loans are 15-year and 30-year mortgages. Today, the United States remains one of the only nations in the world that offers fixed-rate mortgages. 

Special Considerations

While fixed-rate mortgages tend to be more expensive overall than adjustable-rate mortgages, which go up and down with the interest rate, the interest rate remains steady over the lifetime of the loan. The advantage of the rate-improvement mortgage is that a borrower enjoys the benefits of a lowered interest rate without the inconvenience of refinancing the loan and paying the associated refinancing fees.