What is a teaser rate, and how does it work?

Who doesn’t like a good bargain or a discount? The market understands this all too well. And, that’s why, the concept of a teaser rate (aka introductory rate or promotional rate) exists. It’s based on the assumption that a low-interest rate might tempt borrowers to apply for a mortgage loan or a credit card.

What is a teaser rate?

A teaser rate, found in various loan and mortgage products, is a temporary low-interest rate strategically offered by lenders to attract borrowers. This promotional tool is commonly associated with adjustable-rate mortgages (ARMs) and other loans

Your lenders may employ teaser rates with the expectation that you’ll be prompted to apply for a credit card or a loan such as a home equity line of credit (HELOC) with variable interest rates. They serve to entice a diverse range of borrowers. The marketing strategy tries to enhance the appeal of ARMs compared to conventional mortgages. Another example is when an annuity provider might present a favorable interest rate but for a limited time frame.

While the teaser rate appears attractive during the introductory period, borrowers should be aware that it is a temporary feature. And once it concludes, the interest rate adjusts to the market rate, potentially resulting in higher monthly payments.

Are there any good examples of a teaser rate?

The idea behind teaser rates is that more and more borrowers apply for loans or lines of credit. For instance, a credit card company might provide a 0% Annual Percentage Rate (APR) during the introductory period to lure new customers. 

Another example is when an annuity provider might present a favorable interest rate but for a limited time frame.

A different instance of a teaser rate is observed in variable interest rate loans, featuring an initially low rate. Following a brief, predetermined teaser rate period, the rate undergoes an upward adjustment. The pace of this upward adjustment varies among lenders and loan types, as does the maximum limit to which the rate can increase.

It is interesting to note that between 2003 and 2007, subprime mortgages with teaser rates were widespread and played a significant role in causing the 2008 financial crisis. These mortgages offered an initially low fixed teaser rate, but once the introductory period ended, the interest rate on the loans was often set to rise by 2 percentage points or even more.

How does the teaser rate work?

As mentioned before, a teaser rate is a way lenders attract new customers to open accounts or use credit products such as credit cards and adjustable-rate mortgages. Lenders often combine teaser rates with prequalifications, checking credit scores and other details to find eligible borrowers. These rates make products seem appealing, like a mortgage or credit card with a low initial interest rate, or internet service at a discounted start.

The initial teaser rate is usually short-lived. Over time, the rate may increase, making the product or service more costly. For instance, a credit card might offer a 0% introductory rate for 18 months, but after that, it could jump to 13% or even 24%.

Is there a regulatory body regarding these promotional rates?

Yes, to protect consumers, regulations may require lenders to use specific language, such as calling it an introductory or promotional rate so that people know it for what it is. Lenders may also need to assess your financial situation to ensure you can afford the full rate after the teaser period concludes.

On your part, always read the details before committing to teaser rates. Being informed helps you prepare for potential future costs once the initial low rate expires.

Which are the most popular products using teaser rates, in the US?

Credit cards

Such rates are frequently found in credit cards, where the typical rate is 0%. The process is straightforward: for a set period, typically around a year, the cardholder enjoys a 0% rate. When this teaser rate expires, the cardholder is then subject to the standard credit card rate specified in the credit agreement.

Adjustable rate mortgages

Teaser rates are commonly used in ARMs because of the flexibility in how they are structured. In an ARM, borrowers experience different interest rates over the loan’s duration. Initially, there’s a fixed-rate period, followed by variable-rate interest.

Lenders have various ways to incorporate teaser rates in ARM interest payments. It might be an introductory rate during a fixed period, at the loan’s initial reset, or as the minimum payment in a payment option ARM.

Standard ARMs may have a teaser rate for a few months during the fixed period. After the initial fixed-rate period, borrowers can choose from different rate structures, often with caps such as 2-2-6 or 5-2-5. This indicates limits on incremental increases and overall maximum rates.

Lenders also provide payment option ARMs, where a teaser rate in the fixed portion serves as the minimum payment in the variable rate option. During this phase, borrowers can select various payment options, including the minimum teaser rate, interest-only, 15-year fully amortizing payment, or 30-year fully amortizing payments.

What are the advantages and disadvantages of teaser rates?

Last thoughts

A teaser rate typically is the initial rate applied to a credit product. Its aim is primarily to entice borrowers with a low starting rate. It may also extend to investment products such as annuities that offer higher interest rates for a brief period.

While teaser rates create an initial impression of affordability, it’s crucial to recognize their temporary nature. Once the teaser rate expires, payments may significantly increase. Before committing to such rates, do understand the terms and conditions. And, look at the pros and cons carefully.

For those seeking stability, there are alternatives such as fixed-rate mortgages. These offer a consistent interest rate and monthly payment throughout the loan duration. Such loans save you from any surprises due to fluctuating rates.

Written by Ramona Sinha. December 23, 2023

Ramona is the Senior Content Writer for Kukun. This experienced blogger uses simple and succinct words to decipher the complex phenomenon called life. She has written articles covering a broad range of topics, such as real estate, lending and mortgage, finance, business, taxation, home designs, home improvement projects, decor concepts, and more. An avid traveler, she’s a digital nomad at heart and an animal lover from the depth of her soul.