Older woman searching for an ARM Teaser rate online.

A Guide To Teaser Rates: What They Are And How They Affect Your Mortgage

Dan Rafter7-minute read

August 26, 2022

Share:

Credit cards often offer short-term teaser interest rates to attract new customers. Teaser rates usually last for a limited time – often 6 to 12 months for credit cards – and can be as low as 0%. When the teaser period ends, that initial low rate adjusts to the credit card’s standard interest rate – one that’s often far higher. It’s not unusual for credit card teaser rates to shoot up from an APR of 0% to 20% or higher.

But did you know that lenders might also offer teaser rates on mortgage loans? These initial interest rates can be lower than the typical interest rates you get with home loans.

But like with teaser interest rates on credit cards, teaser rates on home loans are temporary. You therefore need to be certain you can afford your monthly mortgage payment if that initial rate adjusts to a higher one. If you can’t afford your payment with the revised rate, you could end up missing mortgage payments and falling into foreclosure.

Let’s learn more about teaser rates and how they relate to home loans. That way, you’ll know exactly what to expect if you encounter teaser rates during the mortgage approval process.

What Is A Teaser Rate?

Lenders typically use teaser rates to market their products to consumers. This is an especially common practice for banks and financial institutions: They’ll offer an annual percentage rate (APR) that’s lower than market rates for a limited time on their credit cards as a way to entice consumers to apply for them.

Teaser rates aren’t quite as common with mortgage loans. For most mortgages, the rate you get when you close your loan is the same one you’ll have until you sell your residence or refinance your mortgage.

Adjustable-rate mortgages, otherwise known as ARMs, are considered an exception to this idea. ARMs feature a low initial interest rate – the teaser rate – for a set number of years before they adjust to a sometimes higher interest rate after this introductory period.

A teaser rate is a low temporary interest rate on a loan that lenders use to entice buyers to apply for their credit cards, mortgage loans or other financial products. Teaser rates are a common feature of adjustable-rate mortgages. These mortgages, better known as ARMs, include a fixed teaser period, usually of 5 – 7 years, before the interest rate adjusts, sometimes to a higher figure.

Understanding Teaser Rates On Home Loans

Some disagreement pervades on whether the initial interest rates that come with ARMs are teaser rates in the traditional sense.

A standard ARM comes with a fixed period and an adjustable one. During the fixed period, the loan has an interest rate that’s typically lower than what borrowers would get with more common fixed-rate loans. This rate will remain in place for as many years as the fixed period lasts, usually 5 or 7.

After the fixed period, the interest rate on the loan adjusts, often once every 6 months to a year, depending on whatever economic index the loan is tied to. In many cases, the interest rate will increase during the adjustment period, causing borrowers’ monthly mortgage payments to rise.

Many consider ARMs an example of teaser rates because when the interest rate is lower, the first fixed period is a type of teaser rate that encourages people to apply and get approved for ARMs.

ARMs have another type of teaser rate, though, albeit less common. Some lenders might offer an even lower initial interest rate with an ARM, one lasting only 1 or 2 months. The loan’s fixed interest rate – still lower than what you’d get with a fixed-rate mortgage – would then kick in after the teaser period ends. The new rate would adjust one more time once the fixed period ends and the loan enters its adjustable period.

These teaser rates are used primarily to entice consumers, much like credit card providers offer 0% interest on new purchases or balance transfers for a limited time. Rocket Mortgage® conventional ARMs adjust twice a year after the fixed period expires.

Find out if an ARM is right for you.

See rates, requirements and benefits.

An Example Of Teaser Mortgage Rates

How do ARMs and teaser rates work?

Let’s say you take out a 5/1 ARM of $300,000 for a 30-year term. This means your interest rate will remain fixed for the first 5 years of the loan and then adjust every year for the last 25 years of the loan.

Your teaser rate, the rate in place for the first 5 years of your loan, will be lower than market rate. Let’s say your interest rate for the first 5 years is 3%. For comparison, let’s also say your interest rate for the entire loan would’ve been 3.8% if you took out a standard 30-year fixed-rate mortgage.

During the first 5 years of your ARM, you’ll have a monthly payment of $1,264, not including property taxes and homeowners insurance. If you had taken out that standard 30-year fixed-rate loan, your monthly payment during those first 5 years – again without taxes or insurance – would be $1,397.

That’s a difference of $133 a month. During the first 5 years, you would’ve paid $7,980 more in total with the 30-year fixed-rate loan than you would have with an ARM.

The situation changes after the 5th year. This is where the risks of an ARM come in. Starting in the 6th year, your loan’s interest rate will adjust according to whatever economic index it’s tied to. In most cases, your interest rate and your monthly payment will go up.

Depending on what’s happening in the economy and with interest rates, your new monthly payment now might be higher than what your monthly payment would’ve been starting in Year 6 if you had taken out a 30-year fixed-rate loan. Or it might not be – you have no way of knowing with absolute certainty.

But what if, for example, your interest jumps enough that your new monthly payment on your 5/1 ARM – not including taxes and insurance – rises to $1,450? That’s now $53 a month more than what you would’ve been paying with that fixed-rate loan. That’s $636 more a year, which can add up if you take the full 30 years to pay off your 5/1 ARM.

There’s a caveat here, though. Many homeowners take out an ARM and then refinance to a standard fixed-rate loan before they hit their ARM’s adjustment period. This way, they can take advantage of the low initial teaser rate of an ARM and then get the benefits of a stable monthly payment once they refinance to a fixed-rate loan.

Just be aware: You’ll generally need at least 20% equity in your home to qualify for a refinance. Equity is the difference between what you owe on your mortgage and what your home is worth. If your home is worth $200,000 and you owe $100,000 on your mortgage, you have $100,000 in equity. If your home’s value doesn’t rise much or at all during your ARM’s fixed-rate period, you might not have earned enough equity to refinance.

Other Considerations For ARMs With Teaser Rates

Is an ARM with a teaser rate a good idea for your home purchase? This depends on a few factors:

  • How long you plan on living in the home: If you don’t plan on staying for more than 5 or 7 years, an ARM with a low teaser rate could save you money. If you sell your home before the teaser rate expires, you won’t have to worry about the higher monthly mortgage payments that will kick in once your loan enters its adjustment period.
  • Whether you can afford the property: Teaser rates may persuade you to purchase more home than you can afford. Why? The low initial rates will give you a monthly mortgage payment that’s artificially low for the home you’re You might be able to afford these payments, but what happens when your interest rate adjusts and your mortgage payment rises? You might not be able to afford these newer monthly payments.
  • Whether it’s worth the long-term financial risk: While a low teaser rate might give you a lower monthly payment for 5 or 7 years, you might end up losing money over the remaining 25 years of a 30-year ARM if the interest rate adjusts and increases. If this is the case, you might be stuck with a higher interest rate for the majority of your loan’s lifespan.

Are Teaser Rates A Good Idea?

Teaser rates can make financial sense. Maybe you’re struggling to pay off thousands of dollars in credit card debt. If you apply for a new credit card that comes with a teaser period offering 0% interest on balance transfers for 12 months, you can transfer your existing debt to this new card and pay it off without worrying about paying interest, as long as you pay off that debt before the teaser period ends.

Teaser rates are more complicated with mortgage loans. You can save money with an ARM that comes with a 5-year or 7-year teaser period. But you must make sure you can afford the higher monthly payments that come if your interest rate rises when your ARM enters its adjustable period.

If your plan is to sell your home or refinance your mortgage before your ARM enters its adjustable period, know that you’re taking on some risk. If home prices fall after you buy your residence, you might not have enough equity to refinance.

What if the housing market slumps and you can’t sell your home? You’re also taking a risk that interest rates on a standard fixed-rate mortgage won’t be too much higher than they are when you take out your ARM.

A good move might be to make sure your credit score is high enough that you qualify for the lowest possible interest rates on any mortgage loan.

If you’re looking for ways to get the best mortgage rate without opting for a teaser rate mortgage, consider paying all your monthly bills on time, paying down as much of your credit card debt as you can and keeping paid-off credit card accounts open, even if you plan on never using that card again.

The Bottom Line

An ARM with a low teaser rate can be a smart financial move. The low initial interest rate can lower your monthly mortgage payments, at least until your ARM enters its adjustable period. Just be aware that your monthly mortgage payment could rise significantly based on market conditions during your loan’s adjustable years.

Whether you’re thinking about borrowing an adjustable- or fixed-rate mortgage, it’s important to get initial mortgage approval at the start of your home-buying journey. Our team of Home Loan Experts can help guide you through the process to ensure you’re getting the best mortgage for your financial situation.

Get approved to see what you can afford.

Rocket Mortgage® lets you do it all online.

Headshot of Dan Rafter

Dan Rafter

Dan Rafter has been writing about personal finance for more than 15 years. He's written for publications ranging from the Chicago Tribune and Washington Post to Wise Bread, RocketMortgage.com and RocketHQ.com.