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An initial rate period on a mortgage or other loan includes an introductory interest rate (sometimes known as a teaser rate) that expires at the end of the period. The initial rate period is only included in those loans that offer an introductory rate, which varies by loan type and can be as short as one month or as long as several years.
Teaser loans are an example of mortgages with initial rate periods that offer very low introductory rates used for promotional purposes to entice new borrowers. Borrowers must be aware of the rates that will apply after the initial rate period expires.
Adjusted-rate mortgage loans (ARMs) come with an initial rate period in which the interest rate varies throughout the loan's life. Typically, the ARM's initial interest rate is fixed for a period of time, after which it resets periodically, often every year or even monthly. The rate resets are based on a benchmark rate or an index. Also, the lender or bank adds an additional cost called the ARM margin.
Typically, the interest rate is lower during the initial rate period, which is usually at the beginning of the loan term. Borrowers should be careful when choosing a loan or mortgage solely based on an attractive, low initial rate period. While a loan with a low initial interest rate can seem beneficial, low initial interest rates will reset to higher rates at the expiration of the initial rate period.
Mortgage loans with a low rate during the initial rate period are also called teaser loans and can help save borrowers a significant amount of money early on. However, please be aware that the rate could reset to a substantially higher rate after the teaser rate expires.
It is essential to perform careful analysis with your mortgage lender to review the interest rate structure, payment terms, and requirements within the loan contract to fully understand the overall cost of the loan.
The initial rate on an adjustable-rate mortgage (ARM) can be lower than a typical fixed-rate mortgage. However, the ARM's rate following a reset can be much higher since it is based on current interest rates, which are impacted by economic conditions.
Some specific ARM loans, such as 3-2-1 buydown mortgages, have a lower rate during the initial rate period, after which the interest rate increases incrementally. The 3-2-1 temporary buydown mortgage allows the buyer a lower initial rate period and provides additional cash up-front during the closing process.
By offering a greater down payment at closing, the buyer can lock in a lower initial rate period and reduce long-term loan costs. The term gets its specific title from the relationship between the initial rate period and the permanent rate. In the first year, the interest will be 3% lower than the permanent rate. In the second year, it will be 2% less, and in the third year, it will be 1% lower.
If you qualify for a mortgage loan at 6% but would like to reduce the mortgage payments for the first few years, you may use a 3-2-1 mortgage buydown. However, the closing costs with this type of loan are higher. With the first year, i.e., the initial rate period, you would pay 3% interest on the borrowed principal. During the second year, the interest rate goes up to 4%. In the final year of the 3-2-1, your interest is 5%. The loan then continues at 6% for the life of the mortgage.
The key here is to do your research to ensure you don’t pay more money for a lower initial rate period than you save.
With an adjustable-rate mortgage, the rate stays the same for the initial period, which might be for a few years. After that, the rate adjusts or resets periodically based on an index or a market interest rate. As a result, following the reset, the rate can be substantially higher than the initial rate.
The initial rate for an adjustable-rate mortgage is called the fixed period, which is when the interest rate doesn't change. The timeframe of the fixed period can vary depending on the ARM, but it can be six months to 10 years.
A 5/1 ARM is a type of adjustable-rate mortgage. The five represents the fixed rate period, meaning the rate stays the same during the first five years. The one means the rate resets once per year after the first five years have passed.
The initial rate period is a time period on a loan, such as a mortgage or credit card, that includes an introductory interest rate that is lower than the remainder of the loan or line of credit. The initial rate for an adjustable-rate mortgage is when the interest rate doesn't change—called the fixed period. The fixed period for an ARM can vary from a few months to 10 years.
Typically, the initial rate is low and resets to a much higher rate following a period of time. As a result, the initial rate is often called a teaser rate. Please be aware that the reset rate can be substantially higher, making the loan unaffordable to some borrowers.
