DEFINITION of 'Initial Interest Rate'
The interest rate that is initially assessed on an adjustable-rate mortgage (ARM) and advertised in the origination process. The initial interest rate will be in force for a limited period of time, typically between 12 and 24 months. After this window of time is closed, the interest rate will reset itself to an index plus spread value that is higher than the initial rate.
May also be called a "teaser rate".
BREAKING DOWN 'Initial Interest Rate'
ARMs with this feature were extremely popular in the 2005 and 2006 period that defined the late stages of the subprime mortgage boom. With interest rates on the rise during this time, these initial teaser rates were key to getting new customers, who might otherwise be deterred by the mortgage costs, to purchase homes. Many customers didn't fully realize what they were getting into, as the fully indexed rate was higher than many could afford. In these situations, the only way the mortgage could be serviced is if the borrower could refinance the entire loan using real estate appreciation equity as the cushion for the switch.