Rollover Mortgage

What Is a Rollover Mortgage?

A rollover mortgage is a mortgage in which the unpaid balance, representing the outstanding principal, must be refinanced every few years at current interest rates, subject to certain limits. Typically, this refinancing process would occur every three to five years. Up until the renegotiation point, the interest rate would remain fixed. That initial fixed interest rate is usually lower than that of a standard fixed-rate mortgage.

How a Rollover Mortgage Works

When agreeing on a rollover mortgage, the initial mortgage contract would spell out the specific terms and restrictions of the loan. For example, it may specify the mortgage interest rate may not increase by more than 0.5% per year or by more than 5% over the life of the loan. The life of a rollover mortgage is commonly 30 years.

A rollover mortgage is sometimes also called a renegotiable-rate mortgage. The purpose of a rollover mortgage is to reduce the mortgage lender's interest-rate risk by passing some of that risk on to the borrower. Variable-rate mortgages have a similar purpose.

Who benefits most from a rollover mortgage? That depends on interest rate trends at that given time. When interest rates are falling, this type of loan benefits the borrower, but when they are rising, it can harm the borrower and is more beneficial to the lender.

A rollover mortgage differs from a hybrid mortgage. With a hybrid mortgage, the interest rate also starts out as fixed, but then the loan changes at a predetermined point to an adjustable-rate mortgage, with the rate changing every year from that point on for the remaining life of the loan.

Some people mistakenly assume a rollover mortgage means that the balance or remaining principal can be rolled over, or included in, the starting balance of a completely new and separate loan.

This would be similar to the practice of carrying over the remaining balance of an existing car loan into the financing for another vehicle when the old vehicle is traded in as part of the transaction. However, in real estate, there is no such practice. Each property must be purchased and financed as its own separate and new transaction.

Disadvantages of a Rollover Mortgage

The primary disadvantage of a rollover mortgage is the risk that is inherent in the structure. A borrower is gambling that interest rates will stay the same for the life of the loan or decrease, meaning that their payments will stay the same or be less. Predicting interest rates is difficult, particularly over a 30-year period.

If interest rates rise, the borrower will have to pay more on their mortgage, which, in many cases could be an expense they cannot afford. It may result in them defaulting on their mortgage or having to sell their home. Not having the certainty of your future mortgage rates is a risky endeavor that increases financial instability.

For this reason, a rollover mortgage would be most suitable for individuals who don't plan on owning the home for the entire life of the mortgage but selling beforehand.

Example of a Rollover Mortgage

A person buys a house and has a $200,000, 30-year mortgage with a 5% interest rate. The person's monthly payment is $1,074. According to the mortgage contract, this rate will remain the same over the next five years, at which point the rate will reset to prevailing interest rates at the time.

In five years, the interest rate has climbed from 5% to 9%. Let's also assume the borrower in that time has paid off $30,000 of their principal, leaving their outstanding mortgage amount at $170,000. Their monthly payment has now increased from $1,074 to $1,427. Not a significant increase, but, depending on the individual, this additional cost of $353 could be impactful.