What Is a Teaser Rate?
A teaser rate generally refers to an introductory rate charged on a credit product. Credits cards may charge borrowers an introductory rate of 0%. Adjustable rate mortgages (ARMs) are also known for charging a low initial rate that helps entice borrowers and increase the marketability of ARMs over traditional mortgages.
BREAKING DOWN Teaser Rate
A teaser rate is one way lenders market new accounts and products to credit customers. Credit cards and adjustable rate mortgages are two of the most common credit products structured with teaser rates.
Generally, lenders will also use prequalifications in conjunction with teaser rates. Through relationships with credit bureaus, lenders can make soft inquiries to obtain lists of borrowers that have credit characteristics that would qualify them for a loan approval. Lenders include teaser rates in credit product prequalification marketing to add incentive for new customers.
Credit cards are one of the most common products offering a teaser rate. The teaser rate is usually 0%. The teaser rate process for a credit card is simple. The borrower pays 0% for a specified period, usually around one year. Once the teaser rate expires, the borrower is charged the standard credit card rate agreed to in the credit agreement.
Adjustable Rate Mortgages
Using teaser rates for adjustable rate mortgages is also common because of the variation in their structuring. In an adjustable rate mortgage, borrowers will pay various rates throughout the life of the loan. In the first few years, the borrower is charged fixed rate interest. After the fixed rate period ends, the borrower begins paying variable rate interest.
Lenders can structure the interest payments on adjustable rate mortgages in many different ways. They may include a teaser rate as an introductory rate in the fixed portion of a loan, at the loan’s initial reset date or as the minimum payment in a payment option ARM.
Standard ARM loans may have an introductory rate during some or all of the fixed interest portion of a loan. An introductory teaser rate in the fixed rate portion of the loan may last for only a few months. A lender can also charge a teaser rate during the entire fixed rate portion of a loan.
ARMs often charge a low initial rate to entice borrowers and increase marketability.
Borrowers in an ARM can have various rate structures to choose from after the initial fixed-rate period ends. Many ARMs include various interest rate cap structures such as a 2-2-6 or 5-2-5. With this rate quote the first number refers to a cap on the initial incremental increase from the fixed rate, the second number is a periodic cap usually based on the product’s reset schedule, and the third number is a lifetime cap which sets the maximum interest rate that can be charged overall. A teaser rate could potentially be implemented in various ways with an interest rate cap structured loan.
Lenders also offer borrowers payment option ARMs. These loans may charge a borrower a teaser rate in the fixed rate portion of the loan that also serves as the minimum payment level in the variable rate payment option portion of the loan. During the payment option portion of the loan, borrowers will have several options to choose from. Options can include a payment with the minimum teaser rate of interest, interest only, a 15-year fully amortizing payment or a 30-year fully amortizing payment.