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You’ve probably seen advertisements promoting 0% APR (annual percentage rate) credit cards or adjustable-rate mortgages (ARMs) with interest rates well below the going rates. These are two examples of teaser rates.
A teaser rate, or introductory rate, is a temporarily low interest rate on loans or credit cards that companies use to market their products. It allows borrowers to access credit at a low rate for a set period of time. But once the introductory period ends, the borrower is responsible for paying the standard, higher interest rate.
It’s common practice for lenders to use teaser rates to attract potential consumers. We’ll take a deeper dive into how these rates work, what to look out for and whether a teaser rate is a good option for you.
What Is a Teaser Rate?
If you’re seeing credit card or mortgage loan rates that seem too good to be true, chances are you’re looking at teaser rates.
A teaser rate is the low introductory rate you’ll pay for a specified number of months or years. However, once that time period ends, you have to start paying the higher, variable interest rate.
What is a teaser rate in real estate?
In real estate, teaser rates are most commonly used with adjustable-rate mortgages (ARMs) and home equity lines of credit (HELOCs) as a way for lenders to entice borrowers with a temporary, low interest rate.
How Do Mortgage Teaser Rates Work?
Lenders charge a mortgage teaser rate for a predetermined period of time, followed by an adjustment to the standard – often higher – loan rate. A mortgage teaser rate gives borrowers a flexible option for financing that can offer lower payments upfront and the freedom to refinance or sell the property before it ends.
Unlike most mortgages, which have fixed interest rates, mortgage teaser rates usually only apply to ARMs, which have variable interest rates and are less common.
Another example of teaser rates in real estate is on HELOCs, which typically have variable rates.
Teaser rates on adjustable-rate mortgages (ARMs)
An ARM is a home loan that begins with a fixed-rate for a certain number of years, followed by a variable rate that periodically changes (typically annually). Though most people choose fixed-rate mortgages, an ARM may work better for home buyers who don’t intend to stay in their home for long.
On the surface, an ARM may appear to have a built-in teaser rate, since the fixed rate that’s charged at the start of the mortgage can be lower than the increase at the end of the introductory period. If added to an ARM, a teaser rate can further decrease the interest paid at the beginning.
There are different ways lenders can structure ARMs, including a 5/1 ARM, 7/6 ARM, 5/6 ARM or 10/1 ARM. If you go with a 5/1 ARM, the five indicates the number of years the interest rate is fixed. After the 5-year introductory period, the interest rate will adjust to the current market rate once per year over the life of the loan.
For example, your interest rate may be 5% for the first 5 years, and then it will go up by 1 – 2% each year after that until you hit your rate cap.
Teaser rates on a home equity line of credit (HELOC)
A HELOC provides you with a revolving line of credit, like a credit card, and uses your home as the collateral. Homeowners can use a HELOC to access cash from their home’s equity. There’s a specific draw period in which you can access the equity – typically 10 years.
At the end of the draw period, the variable interest rate repayment begins. The interest rate can change each month during the repayment period, increasing or decreasing in response to national interest rates.
Teaser rates offer borrowers a discount on interest charges in the early months or years of a HELOC, after which the interest rate changes to a standard, variable rate. As a borrower, this can mean higher savings on interest payments upfront at the price of unpredictable, potentially higher payments after the teaser rate period expires.
For instance, a HELOC teaser rate might start at 6% for 1 – 2 months. Then in 6 months, it changes by 1% and the next month it’s 3% higher. That can be a big jump in your monthly payment, so be sure you plan ahead.
Are Mortgage Teaser Rates a Good Idea?
Depending on the situation, mortgage teaser rates can be a good idea – but only if you understand the risks and have a plan for paying off the debt.
If you plan on being in your home long term and want to make fixed mortgage payments without having to refinance, a loan with a teaser rate may not be right for you.
If you want to take advantage of low rates at the start and don’t mind refinancing or managing the change in interest rates, a teaser rate can be a money-savvy option.
Here are some more pros and cons you’ll want to consider before deciding if it’s the right choice for you.
PROS of Mortgage Teaser Rates👍
Mortgage teaser rates mean lower monthly payments early on in the loan, which helps free up extra cash. You can use that additional cash flow to your advantage by paying off other debt, building your savings or investing.
Mortgage teaser rates can last for several years, and you could choose to sell your home before the adjusted rate goes into effect. If you sell before the end of the introductory rate period, you won’t have to worry about higher rates kicking in.
Many people choose to refinance their ARM – to a different ARM or a fixed-rate mortgage – before the end of the teaser period to avoid higher rates.
Teaser rates can be helpful to home buyers who want to take advantage of lower initial payments while current mortgage rates are higher. Then if rates go down later, you could end up paying less overall.
CONS of Mortgage Teaser Rates👎
You may end up paying a significantly higher interest rate – up to your rate cap – once the introductory period ends. Though the rate isn’t guaranteed to increase, it is a possibility to consider.
If you choose an ARM with a teaser rate and interest rates go up when it expires, you may end up paying more interest over the life of the loan compared to a fixed-rate mortgage.
A variable rate can make planning and budgeting a challenge. If you prefer to make fixed, consistent payments over the life of a loan, the variability of a mortgage teaser rate is an obvious disadvantage.
Teaser rates can make early mortgage payments lower upfront, which may lead people to buy more home than they can afford. Once the introductory period ends and your mortgage payments increase, an affordable home can quickly become unaffordable.
It’s Called a Teaser For a Reason
Teaser rates urge you to consider a loan or apply for a credit card with enticing interest rates. The key is to remember that these too-good-to-be-true rates won’t last long.
If you’re thinking of applying for an ARM or a HELOC, keep in mind that teaser rates come with an expiration date – then use that knowledge to your financial advantage.
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