What are mortgage teaser charges?
What is a Mortgage Teaser Rate?
A teaser course is a marketing tool that lenders use to attract borrowers. You get a low introductory interest rate that later jumps to or above the market rate.
Most homeowners opt for a fixed-rate mortgage. With these you don’t have to worry about teaser rates, because your interest rate is fixed for the term of the loan.
However, if you want a variable rate home loan – like a variable rate mortgage or HELOC – you should understand how mortgage teaser rates work.
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Mortgage Teaser Rates Explained
If you’ve ever seen offers for 0% APR credit cards, you already know the concept of teaser tariffs. You do not pay any interest on the plastic for a set period of time. And then a much higher rate sets in.
But what does that have to do with mortgages?
Mortgage Loans With Teaser Rates
Mortgage teaser rates can appear on an adjustable rate mortgage (ARM) or home equity line of credit (HELOC) – a form of second mortgage.
These types of loans have “floating rates”, which means that lenders can offer a lower introductory (teaser) rate that can eventually be adjusted upwards.
However, you are much less likely to encounter mortgage teaser rates today than in the past. You were part of the irresponsible lending that led to the 2007-08 credit crunch. As a result, consumers, lenders, and regulators in the mortgage industry are keen to avoid the worst deals of the time.
ARM loans usually still advertise lower initial rates than fixed home loans. But the adoption or “teaser” rate may not be as artificially low as it has been in the past.
If you want a standard fixed-rate mortgage (FRM) then you don’t have to worry about these teasers at all.
Yes, some lenders advertise low prices for FRMs that you can only get if you buy discount points upon completion. And some ultra-low prices that you see advertised are only available to those with pristine credit and 20% off.
But these are not teaser rates in the usual sense; If you qualify for this extremely low fixed price, you’ll keep it for the long term.
Check your mortgage rates. Start here (23.06.2021)
What happens when the teaser rate expires?
When the teaser rate for an ARM or HELOC expires, your mortgage rate may change. If interest rates have risen since the loan was opened, your mortgage rate – and the monthly payment – could go up.
Exactly how high your new interest rate will be depends on the broader interest rate market.
That’s because ARM and HELOC rates are typically tied to external rate indices, which are often published daily in the Wall Street Journal. This is called the current key rate index of the WSJ. But there are many others. And your mortgage contract will state which index yours is tied to.
Of course, your tariff will be considerably higher than this base tariff. Because your loan is far riskier than what you are giving out to the big banks and huge multinationals that really can’t borrow for next to nothing.
To offset this additional risk, a “margin” is added to the Base Rate and you pay that margin plus the Base Rate. But your ARM or HELOC rate will go up or down according to the index you choose.
This is how ARM loans work
Mortgage borrowers are most likely to encounter teaser rates when looking for adjustable rate mortgages. Hence, it is important to understand how these ARM rates work.
ARMs come in a variety of flavors including 1/1, 2/1, 3/1, 5/1, 7/1, and 10/1.
The first number indicates how many years the fixed introductory price applies. After that, your interest rate will float in line with the broader interest rates.
It’s worth noting that the shorter the time your price is set, the lower the initial interest rate. (For example, a 5/1 ARM should have a lower intro rate than a 10/1 ARM.)
The second number (the ‘1’) indicates how often your tariff can be reset after the introductory fixed tariff has expired. A ‘1’ means that it can float up or down once a year.
If you are certain that you will be moving before the low fixed rate expires, you can be sure to get an ARM and never face a rate hike. After the introductory phase has expired, you will have a new mortgage. Keep in mind, however, that the average mortgage rate when you take out your next loan can be much higher.
Adjustable interest rate caps
Nowadays, ARMs and HELOCs often come with rate caps. And you need to sift through your mortgage listing (‘Loan Estimate’) to make sure that:
- It includes rate caps – not all do
- These caps provide reasonable protection against sudden, sharp rate hikes
These caps often apply in three ways. You indicate the maximum amount that your tariff can increase:
- The first time your rate is adjusted (when the initial fixed income period ends)
- Every time a tariff review is allowed (usually once a year)
- Overall: Your rate can never exceed x%
You need to model a worst-case scenario to tell you how much your interest rate and loan payments could go up if interest rates go up.
This exercise used to feel theoretical. But the aftermath of the COVID-19 pandemic has made significantly higher rates a real possibility.
Therefore, check page 2 of the credit estimates you receive from lenders. Each shows an Adjustable Interest Rate (AIR) table that contains your caps and other information.
Learn as much as you can
Make sure you are 100% aware that you are facing higher rates. And be sure to consult an independent professional and read on.
The 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 the 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 will take on the fully indexed interest rate.
“Don’t assume that a loan with a teaser rate is good for you. Not every household can take a higher payment. “
Can a teaser plan save you money?
You bet! Those who have taken ARMs in the last decade or so have generally seen savings. In some cases, their mortgage loan rates have even fallen in line with other rates. And they are spared refinancing in order to be able to access the lowest mortgage rates.
Aside from the teasers, ARM rates tend to be significantly lower than those on fixed-rate loans. So many aspiring homeowners see ARMs as a quick and inexpensive way to get up the ladder of their home.
Because the borrower bears part of the risk of rising interest rates. With fixed income products, the lender bears all of this risk – typically for up to 30 years.
But are the good times over? Many expect an economic boom from the end of the pandemic. And they almost always bring significantly higher interest rates.
Where will these rates be after the five or seven years of a 5/1 or 7/1 ARM? How does a higher monthly mortgage payment affect your household budget?
As I said, before you sign up, consider all the pros and cons of an ARM loan.
What are the mortgage rates today?
It is 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 deadline) should continue to see savings on their mortgage payments.
However, it is questionable whether the bill still works so cheaply if you add the final costs for refinancing and such plus moving costs for the change of residence.
Remember, low interest rates are currently the norm on all types of loans.
Borrowers with solid credit ratings and a down payment can typically make big money in today’s mortgage market without taking the risks of an adjustable rate loan.
Check with some mortgage lenders to see what type of deal you are ready for. You may find that you can secure yourself a low interest rate and monthly payment without choosing a teaser plan.
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