What are mortgage teaser rates?
A teaser rate is a marketing device used by lenders to attract borrowers. You get a low introductory interest rate that later jumps to or above the market rate. Most homeowners choose a fixed-rate mortgage. With these, you dont have to worry about teaser rates because your interest rate is fixed for the life of the loan. But if you want a home loan with a variable rate  like an adjustable-rate mortgage or HELOC  youll want to understand how mortgage teaser rates work. In this article (Skip to)  Mortgage teaser rates explained  If youve ever seen offers for 0% APR credit cards, youre already familiar with the concept of teaser rates. You pay zero interest on the plastic for a set period of time. And then a much higher rate kicks in. Mortgage loans with teaser rates  Mortgage teaser rates can crop up with an adjustable-rate mortgage (ARM) or home equity line of credit (HELOC)  a form of the second mortgage. These loan types have variable rates, meaning lenders are able to offer a lower (teaser) introductory rate which can eventually adjust upward. However, youre much less likely to encounter mortgage teaser rates today than in the past. They were a part of the irresponsible lending that led to the 2007-08 credit crunch. So consumers, lenders, and regulators in the mortgage industry are keen to avoid the worst types of offers seen back then. ARM loans typically still advertise lower initial rates than fixed home loans. But the introductory or teaser rate may not be as artificially low as you would have seen in the past. Fixed-rate mortgages  If you want a standard, fixed-rate mortgage (FRM), you dont have to worry about these teasers at all. Yes, some lenders will advertise low rates on FRMs that you can only get if you buy discount points at closing. And some ultra-low rates youll see advertised are only available to those with pristine credit and 20% down. But those arent teaser rates in the usual sense; if you do qualify for that ultra-low fixed rate, you keep to keep it for the long haul. When the teaser rate on an ARM or HELOC expires, your mortgage interest rate can change. If interest rates have increased since you opened the loan, your mortgage rate  and monthly payment  could rise. Exactly how high your new rate will be will depends on the broader interest rate market. Thats because ARM and HELOC rates are typically tied to external rate indexes, often the one published daily in The Wall Street Journal. Thats called the WSJ current prime rate index. But there are many others. And your mortgage agreement will specify which index yours is tied to. Of course, your rate will be considerably higher than that prime rate. Because your loan is much riskier than those made to the big banks and huge multinationals that really do get to borrow for next to nothing. To make up for that extra risk, a margin will be added to the prime rate and that margin plus the prime rate is what youll pay. But your ARM or HELOC rate will go up or down in line with its chosen index. How ARM loans work  Mortgage borrowers are most likely to encounter teaser rates when shopping for adjustable-rate mortgages. So its important to understand how those ARM rates work. ARMs come in several flavors, including 1/1, 2/1, 3/1, 5/1, 7/1, and 10/1. The first number indicates the number of years the fixed, introductory rate lasts. After that, your rate will float in line with wider interest rates. Its worth noting that the shorter the time your rate is fixed, the lower that initial rate will be. (For instance, a 5/1 ARM should have a lower intro rate than a 10/1 ARM.) The second number (the 1) tells you how often your rate can be reset after the introductory fixed rate ends. A 1 means it can float up or down once every year. Of course, if youre sure youre going to move before the low fixed rate expires, you can safely get an ARM and never face a rate hike. Youll have a new mortgage by the time the introductory period is up. However, note that average mortgage rates might be much higher when you take out your next loan. Adjustable rate caps  Nowadays, ARMs and HELOCs often come with rate caps. And you need to scour your mortgage offer (Loan Estimate) to make sure:  It contains rate caps  Not all do Those caps provide an adequate level of protection against sudden, sharp rate rises  These caps often apply in three ways. They specify the maximum amount your rate can rise:  The first time your rate adjusts (when the initial, fixed-rate period ends) Each time a rate review is allowed (usually once per year) Overall: Your rate can never rise above x%  You need to model a worst-case scenario to tell you how much your rate and loan payments could increase if interest rates shoot higher. This exercise used to feel theoretical. But the aftermath of the COVID-19 pandemic has made significantly higher rates a real possibility. So check page 2 of the Loan Estimates you receive from lenders. Each shows an Adjustable Interest Rate (AIR) Table, which lays out your caps and other information. Learn as much as you can  Make sure youre 100% clear about your exposure to higher rates. And, by all means, consult an independent professional and read more widely. Financial regulator the Consumer Financial Protection Bureau publishes an excellent booklet called the Consumer Handbook on Adjustable Rate Mortgages. Perhaps the most important piece of advice that booklet contains is:  Some lenders offer a teaser, start, or discounted rate that is lower than their fully indexed rate. When the teaser rate ends, your loan takes on the fully indexed rate. Dont assume that a loan with a teaser rate is a good one for you. You bet! Those who have taken ARMs over the last decade or so have generally seen savings. In some cases, their mortgage loan rates have actually fallen in line with other interest rates. And theyve been spared the expense of refinancing in order to access the lowest mortgage rates. Leaving aside teasers, ARM rates are typically noticeably lower than those for fixed-rate loans. So many would-be homeowners see ARMs as a quick and inexpensive way to get onto the homeownership ladder. Thats because the borrower is shouldering some of the risk of rising rates. With fixed-rate products, the lender carries all that risk  usually for up to 30 years. Many expect the end of the pandemic to bring an economic boom. And those almost always bring significantly higher interest rates. As we said, consider all the pros and cons of an ARM loan before signing on. Its almost certain that ARMs will continue to have lower rates than FRMs. So home buyers who use them strategically (and move or refinance before the fixed-rate introductory period ends) should still see savings on their mortgage payments. However, its debatable whether the math still works as favorably when you add in closing costs for refinances and those plus moving expenses for changing homes. Keep in mind, low interest rates are the norm across all types of loans right now. Borrowers with a solid credit score and down payment can typically get a great deal in todays mortgage market  without taking on the risks of an adjustable-rate loan. Check with a few mortgage lenders to see what kind of deal youre in line for. You might find you can secure a low interest rate and monthly payment without choosing a teaser rate. Verify your new rate (Jun 22nd, 2021)