Definition
A teaser rate is a contract interest rate charged on an adjustable-rate mortgage (ARM) for the initial adjustment interval that is significantly lower than the fully indexed rate at the time. It serves as an incentive to encourage borrowers to accept ARMs by providing them with attractive initial payment terms. Typically, after the initial period, the interest rate readjusts to the prevailing fully indexed rate as per the loan agreement.
Examples
To understand teaser rates better, here are a few practical examples:
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Example One:
- Loan Type: Adjustable-Rate Mortgage (ARM)
- Fully Indexed Rate: 5%
- Teaser Rate: 3%
- Initial Period: 1 year
In this case, the borrower enjoys a 3% interest rate for the first year of the mortgage, after which the rate adjusts to 5%.
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Example Two:
- Loan Type: 5/1 ARM (Adjustable-Rate Mortgage with a fixed rate for the first five years)
- Fully Indexed Rate: 6%
- Teaser Rate: 4%
- Initial Period: 5 years
Here, the borrower pays a 4% interest rate for the first five years of the mortgage. At the end of the five-year period, the interest rate adjustments begin, aligning with the fully indexed rate, which could be 6% or higher depending on market conditions.
Frequently Asked Questions (FAQs)
1. What is the purpose of a teaser rate?
A teaser rate aims to attract borrowers by initially offering lower monthly payments. This can be particularly appealing to those seeking lower upfront costs.
2. How long does a teaser rate last?
Teaser rates typically last for a fixed period, commonly ranging from six months to several years, depending on the loan terms. After this period, the rate adjusts to the fully indexed rate.
3. Can teaser rates lead to higher payments in the future?
Yes, once the teaser rate period ends, the loan interest rate resets to the fully indexed rate, which could significantly increase monthly payments.
4. Are teaser rates available only for adjustable-rate mortgages?
Mostly, yes. Teaser rates are predominantly offered on adjustable-rate mortgages as an introductory feature to potential borrowers.
5. How can I calculate the fully indexed rate?
The fully indexed rate is the sum of the index rate (which can vary) and the margin specified in the loan agreement.
6. What happens if interest rates rise during the teaser period?
If interest rates rise during the teaser period, the new rate upon adjustment could be higher than anticipated, leading to increased monthly payments post-adjustment.
Related Terms
- Adjustable-Rate Mortgage (ARM): A type of mortgage where the interest rate applied on the outstanding balance varies throughout the life of the loan.
- Fully Indexed Rate: The interest rate on an adjustable-rate mortgage after the initial teaser rate has expired, equivalent to the index rate plus the margin.
- Index Rate: A benchmark interest rate that reflects general market conditions and fluctuates over time, used to determine the fully indexed rate on an ARM.
- Margin: The embedded interest rate factor that remains fixed and is added to the index rate to determine the fully indexed rate on an ARM.
Online Resources
- Consumer Financial Protection Bureau (CFPB): Understanding Adjustable-Rate Mortgages
- Bankrate: Adjustable-Rate Mortgages Explained
- Investopedia: Adjustable-Rate Mortgages (ARMs)
References
- Investopedia: Teaser Rate
- Consumer Financial Protection Bureau (CFPB): Mortgage Terms
Suggested Books for Further Study
- “The Mortgage Encyclopedia” by Jack Guttentag: A comprehensive resource for understanding mortgage options, including adjustable-rate mortgages and teaser rates.
- “Mortgage Management for Dummies” by Eric Tyson and Robert S. Griswold: Offers practical advice on managing mortgages and understanding various interest rates.
- “Housing Finance in Emerging Markets” by Doris Köhn: Examines global mortgage markets and various financing models.
