What is a mortgage teaser rate?
A teaser rate is a marketing tool used by lenders to attract borrowers. You get a low introductory interest rate which then climbs to or above the market rate.
Most homeowners choose a fixed rate mortgage. With these, you don’t have to worry about teaser rates as your interest rate is fixed for the life of the loan.
But if you want a variable rate home loan, like an adjustable rate mortgage or HELOC, you’ll want to understand how mortgage rates work.
Check your mortgage interest rates. Start here (June 22, 2021)
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Mortgage teaser rates explained
If you’ve ever seen 0% APR credit card offers, you’re already familiar with the concept of teaser rates. You pay no interest on the plastic for a specified period of time. And then a much higher rate kicks in.
But what does this have to do with mortgages?
Mortgages with teaser rates
Mortgage interest rates can arise with an adjustable rate mortgage (ARM) or home equity line of credit (HELOC) – a form of second mortgage.
These types of loans have “variable rates” which means that lenders are able to offer a lower introductory rate (temptation) that can eventually adjust upwards.
However, you are much less likely to experience mortgage mortgage rates today than in the past. They were part of the irresponsible lending that led to the 2007-08 credit crunch. Consumers, lenders and mortgage regulators are therefore keen to avoid the worst types of offers seen at the time.
ARM loans usually still advertise lower initial rates than fixed home loans. But the introductory or “teaser” rate may not be as artificially low as you might have seen in the past.
Fixed rate mortgages
If you want a Standard Fixed Rate Mortgage (FRM), you don’t have to worry about these hooks at all.
Yes, some lenders advertise low rates on FRMs that you can only get if you buy discount points at close. And some ultra-low rates you’ll see advertised are only available to those with clean credit and 20% off.
But these are not teaser rates in the usual sense of the word; If you do benefit from this ultra-low fixed rate, you keep it for a long time.
Check your mortgage interest rates. Start here (June 22, 2021)
What happens when the teaser rate expires?
When the teaser rate on an ARM or HELOC expires, your mortgage interest rate may change. If interest rates have gone up since you took out the loan, your mortgage rate – and your monthly payment – could go up.
The exact level of your new rate will depend on the broader interest rate market.
This is because the ARM and HELOC rates are generally linked to external rate indices, often the one published daily in the Wall Street Journal. This is called the WSJ Current Prime Rate Index. But there are many more. And your mortgage contract will specify which index yours relates to.
Of course, your rate will be considerably higher than this prime rate. Because your loan is much riskier than those given to the big banks and the big multinationals which can really borrow for next to nothing.
To compensate for this additional risk, a “margin” will be added to the prime rate and this margin plus the prime rate is what you will pay. But your ARM or HELOC rate will increase or decrease depending on the index chosen.
How ARM Loans Work
Mortgage borrowers are the most likely to experience hook rates when purchasing variable rate mortgages. It is therefore important to understand how these ARM rates work.
ARMs are available in several versions, including 1/1, 2/1, 3/1, 5/1, 7/1 and 10/1.
The first number indicates the number of years that the fixed introductory rate lasts. After that, your rate will float according to the wider interest rates.
It should be noted that the shorter the duration of your rate fixation, the lower the initial rate will be. (For example, an ARM 5/1 should have a lower introductory rate than an ARM 10/1.)
The second number (the “1”) tells you how often your rate can be reset after the end of the introductory fixed rate. A “1” means it can float up or down once a year.
Of course, if you are sure you are moving before the low fixed rate expires, you can safely get an ARM and never face a rate hike. You will have a new mortgage at the end of the introductory period. However, be aware that average mortgage rates can be much higher when you take out your next loan.
Adjustable rate caps
These days, ARMs and HELOCs often come with rate caps. And you need to go through your home loan offer (“Loan Estimate”) to make sure:
- It contains price caps – not all of them
- These caps provide an adequate level of protection against sudden and sudden rate hikes
These caps often apply in three ways. They specify the maximum amount that your rate can increase:
- The first time your rate adjusts (at the end of the initial fixed rate period)
- Whenever a tariff revision is authorized (usually once a year)
- Overall: Your rate can never exceed X%
You need to model the worst-case scenario to tell yourself by how much your rate and loan payments could increase if interest rates soar.
This exercise seemed 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 get from lenders. Each displays an Adjustable Interest Rate (AIR) table, which shows your limits and other information.
Learn as much as you can
Make sure you are 100% sure of your exposure to higher rates. And, by all means, consult a freelance professional and read more.
The financial regulator, the Consumer Financial Protection Bureau, publishes an excellent brochure called the A Consumer’s Guide to Variable Rate Mortgages.
Perhaps the most important advice in this booklet is:
“Some lenders offer a“ teaser ”,“ starting ”or“ reduced ”rate lower than their fully indexed rate. When the teaser rate ends, your loan takes the fully indexed rate.
“Don’t assume that a loan with an interest rate is right for you. Not everyone’s budget can accept a higher payment.
Can a teaser price save you money?
You bet! Those who have taken MRAs in the past decade have generally saved money. In some cases, their mortgage rates have actually gone up fallen in line with other interest rates. And they have been spared the cost of refinancing in order to access the lowest mortgage rates.
Teasers aside, ARM rates are generally significantly lower than fixed rate loans. So many would-be homeowners see MRAs as a quick and inexpensive way to access the homeownership ladder.
This is because the borrower assumes part of the risk of rising rates. With fixed rate products, the lender bears all of this risk, usually up to 30 years.
But are the beautiful days over? Many expect the end of the pandemic to lead to an economic boom. And these almost always lead to significantly higher interest rates.
Where will those rates be after five or seven years of a 5/1 or 7/1 MRA? What impact will a higher monthly payment have on your household budget?
As we said, consider all the pros and cons of an ARM loan before signing.
What are the mortgage rates today?
It is almost certain that ARMs will continue to have lower rates than FRMs. So homebuyers who use them strategically (and move or refinance before the fixed-rate introductory period ends) should still save money on their mortgage payments.
However, it is debatable whether the calculations still work so favorably when you add in closing costs for refinances and those plus moving costs to change homes.
Keep in mind that low interest rates are the norm for all types of loans at this time.
Borrowers who have a strong credit score and a down payment can usually get a lot in today’s mortgage market without taking the risks of an adjustable rate loan.
Check with a few mortgage lenders to see what type of deal you are in online. You may find that you can get a low interest rate and a monthly payment without choosing a hook rate.
Check your new rate (June 22, 2021)