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 low, temporary credit card or loan interest rate companies use to market their financial products to borrowers. A teaser rate allows borrowers to access credit at a low rate for a set period of time. 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 borrowers. We’ll take a deeper dive into how teaser rates work, what to look out for and whether a teaser rate is a good option for you.
What Does Teaser Rate Mean?
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 a borrower pays for a specified number of months or years. Once the teaser rate period expires, the borrower pays the higher, variable interest rate.
What is a teaser rate in real estate?
Teaser rates in real estate 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 standard (higher) loan rates. Mortgage teaser rates give borrowers a creative, flexible option for financing that can offer lower payments upfront and the freedom to refinance or sell the property before the teaser rate 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 application for teaser rates in real estate lending is on home equity lines of credit (HELOCs), which typically have variable rates.
Teaser rates for 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 charged at the start of the mortgage can be lower than the potential increase at the end of the introductory period. If added to an ARM, a teaser rate can further decrease the interest paid in the initial period, though this isn’t very common, given the already below-average rates in the early years of an ARM.
There are different ways lenders can structure ARMs, including 5/1, 7/6 or 10/1. If you got a 5/1 ARM, the 5 would indicate the number of years the interest rate is fixed. After the 5-year introductory period, the interest rate will adjust to the going market rate every year over the life of the loan.
For example, your interest rate may be 4% for the first 5 years, followed by a rate of 5.25% in year 6 and 5.65% in year 7.
Teaser rates for a home equity line of credit (HELOC)
First, let’s explain how a HELOC works. A HELOC provides homeowners with a revolving line of credit (like a credit card) using the home as collateral. Homeowners can use a HELOC to tap into their home’s equity and access cash during its draw period, which is typically 10 years.(
At the end of the draw period, the variable interest rate repayment period begins. The interest rate can change each month during the repayment period, increasing or decreasing in response to national interest rate benchmarks, such as the U.S. prime rate.
Teaser rates offer borrowers a discount on interest charges in the early months or years of a HELOC, after which the interest rate reverts to a standard, variable rate. As a borrower, that 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 offer an introductory rate of 2.1% for 1 or 2 months. After 6 months the 5.25% variable rate kicks in and the month after that the rate is 5.36%.
Are Mortgage Teaser Rates a Good Idea?
Mortgage teaser rates can be a good idea for borrowers in certain situations – but only if you understand the risks and have a plan. Mortgage teaser rates offer borrowers flexibility during the introductory period, but the rate can be unpredictable once it ends.
Here are some of the pros and cons of mortgage teaser rates:
Pros of mortgage teaser rates
Mortgage teaser rates are a unique tool if you understand the benefits.
- Availability of additional funds during the introductory period: 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.
- Option to sell the house before the higher rate adjustment kicks in: Mortgage teaser rates can last for several years, and you can always sell your home before the adjusted rate goes into effect. If you choose to sell your home before the end of the introductory rate period, you’ll never have to worry about higher rates kicking in.
- Flexibility to refinance near the end of the teaser rate: 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.
- Save money with an introductory period of lower interest charges: Teaser rates can be helpful to home buyers who want to take advantage of lower initial payments.
Cons of mortgage teaser rates
For all their benefits, mortgage teaser rates come with some drawbacks.
- The interest rate can dramatically increase over time: You may end up paying a significantly higher interest rate once the introductory period ends. Though the rate isn’t guaranteed to increase, there’s no way to know how high it can go.
- You could end up paying more interest over the life of the loan: If you choose an ARM with a teaser rate, you may end up paying more interest over the life of the loan compared to a fixed-rate mortgage.
- Planning and budgeting can be difficult due to variable rates: 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.
- You may purchase more home than you can afford: Teaser rates can make early mortgage payments lower upfront, which sometimes leads people to buy more home than they can afford. Once the teaser rate expires and your mortgage payments increase, an affordable home can quickly become unaffordable.
If you plan on being in your home long term and want to make fixed mortgage payments without having to refinance, the loan with the teaser rate may not be right for you.
If you want to take advantage of introductory low rates and don’t mind refinancing or managing unpredictable interest rates, a teaser rate can be a money-savvy option.
While you don’t know in which direction interest rates will move, you can try to safeguard yourself by looking at ARMs with rate caps. An ARM with a rate cap offers the upfront savings of an ARM and limits on how much the rate can fluctuate. You can also find HELOCs with rate caps, which set an upper limit on rate increases for the life of the loan, guaranteeing it doesn’t exceed a certain number. Rate caps can be helpful for someone who isn’t quite comfortable with the idea of a future rate that’s significantly higher than they can manage and afford.
Do the math on different mortgage scenarios with our mortgage calculator to estimate monthly mortgage payments for different interest rates.
It’s Called a Teaser for a Reason
Teaser rates are aptly named. They are tempting interest rates that are teasing you to consider a loan or apply for a credit card. The key is to never forget that these too-good-to-be-true rates are temporary.
If you’re thinking of applying for an ARM or a HELOC, always keep in mind that teaser rates come with an expiration date – then use that knowledge to your financial advantage.
Freddie Mac. “Choosing Between a Fixed-Rate and an Adjustable-Rate Mortgage.” Retrieved May 2022 from https://myhome.freddiemac.com/blog/homeownership/choosing-between-fixed-rate-and-adjustable-rate-mortgage
The Federal Reserve Board. “What You Should Know About Home Equity Lines of Credit.” Retrieved May 2022 from https://files.consumerfinance.gov/f/201204_CFPB_HELOC-brochure.pdf