As interest rates bounce up and down, some savvy borrowers are enjoying the down side.

A growing number of automatic rate reduction (ARR) loans -- for both prime and subprime borrowers -- are allowing borrowers to cash in on what amounts to an adjustable rate mortgage in reverse.

ARR loans' interest rates fall with the market, just as ARMs rise when the market is up.

With an ARR, however, once the rate is down it can't go back up, but it could get lower still.

The "Declining Rate Loan" from San Diego, CA-based City Line Mortgage allows borrowers to lower their rate by as little as 1/4 percent, even after only a single mortgage payment on a new loan, according to Jim Riley, City Line's CEO.

Borrowers must have pristine credit records and an unblemished payment history.

Fees for the new rate depend on the locality, but typically include only the cost to buy title insurance and to file a new deed of trust -- almost always cheaper than refinancing costs.

The loans obviously are a better deal when rates are steadily declining. In any market, borrowers should do the math to determine if a traditional refinanced mortgage or an ARR adjustment is cheaper.

Depending on the lender, ARRs aren't always available for a jumbo loan, Federal Housing Administration and Veteran's Administration loans.

Some prime ARRs also come with longer waiting periods between rate drops and the special loans invariably come with starting rates as much as a full percentage point higher than going fixed rate mortgages. As such, even when market rates drop, ARRs can lag above the going rate. Once market rates turn back up, of course, ARR holders benefit with a locked-in reduced rate.

Fairfax, VA-based National City Mortgage offers the ARC Loan (for "Automatic Rate Cut"), for jumbos, FHAs and VAs, as well as conforming loans, but they cost at least a half percentage point more than the going rate. You also must wait for four months between rate reductions.

ARR loans are designed to promote customer loyalty but also to retain loan related income -- a lender holds onto customers, loans and servicing income to offset lost refinancing revenues.

Subprime ARRs

Subprime ARRs come with starting rates higher than prime ARRs, but the less flexible ARRs help credit-impaired borrowers get a second chance.

More than two dozen lending outlets, including the Internet's iOwn.com, offer Fannie Mae's "Timely Payment Reward".

Beginning with a mortgage rate as low as two percent lower than typical loans for credit-impaired borrowers, Timely Payment loans automatically adjust down 1 percent after 24 delinquent-free monthly payments.

For example, with the Fannie Mae loan, a credit-impaired borrower may be eligible for a 30-year, 9.5 percent fixed-rate, $125,000 mortgage with a monthly payment of $1051.07.

After two years without delinquency, the borrower's interest rate would drop to 8.5 percent and the monthly payments to $961.15.

An average subprime interest rate of 11.5 percent would cost $1,237.87 a month.

"Through dramatic improvements in our risk-assessment technology, which enables us to more precisely identify a borrower's risk of defaulting on his or her home, we can say 'yes' to more borrowers and extend our service to them at lower costs," said Fannie Mae chairman and CEO, Franklin D. Raines.

Some private subprime lenders offer ARRs with starting rates higher than Fannie Mae's program, but the cuts can be deeper.

Irving, TX-based The Associates, for example, offers a "Freedom Loan" with up to 2.25 percent in downward adjustments over three years.

After 12 consecutive on-time payments, the rate drops 0.50 percent, another 0.75 percent after 12 more payments, and another 1 percent after 12 additional on-time payments.