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Teaser Loan

By definition, a teaser loan, also called an adjustable rate mortgage loan, is where the interest is paid at a very low rate by the borrower, which eventually accelerates after a few years. The initial interest rates are artificial and temporary in nature.

Teaser Loan: How do they work?

The adjustable rate mortgage (ARM) requires a specific benchmark, such as a prime rate, a year treasury with constant maturity, or any other benchmarks. It also corresponds to the margin that is based on the credit score of the borrower. Hence, the benchmark combined with the spread is the interest rate charged on the loan. When ARM’s offer a discounted index rate, it is called ‘teaser rate’ (usually in the first year) thus, making them teaser loans.

An example:

To comprehend how teaser rates affect the borrower’s payment, let’s assume:

Bank A offers $100,000 ARM to Jack. The interest rate charges I prime plus at 5% and a cap of 10%. If the prime rate is at 3% then Jack’s interest would be 5 plus 3 and at 8% and makes the monthly payment at $733.77. Now say, the prime rate increases to 4% then the loans interest rate would increase to 9%, increasing the payment to $804.63

In most cases, the ARMs will have caps. It is the limit on how high or how low the interest rate can go in a year, quarter, month, and how much they are free to move as well. However, in some cases it might be that the interest rate will adjust only if it’s in the upwards trend, that means that the borrowers will be at no luck if the interest rates fall.

How it matters?

The concept of teaser loan is to acknowledge the risk that both lenders and borrowers will benefit if rates will favorably change. Thus, ARMs are complex to deal with. For this reason, borrower needs to read and understand the documents provided by the lenders. Borrowers need to be sure that they can handle the worst implications when forced to pay for high interest rates on mortgages. On the lenders end, they are obliged to disclose how high a monthly payment can go for the borrower.


Further Reading


Teaser rates in conventional adjustable-rate mortgage (ARM) markets
link.springer.com [PDF]
… Tests of the pricing of California ARM teasers when base rate is held constant, 1989 (dependent … 3) and assuming BT = B (ie, the lender chooses not to offset the teaser by charging … Buser, SA, Hendershott, PH, and Sanders, AB "Pricing Life of Loan Rate Caps on Default-Free …

Causes of the financial crisisCauses of the financial crisis
www.tandfonline.com [PDF]
… Tests of the pricing of California ARM teasers when base rate is held constant, 1989 (dependent … 3) and assuming BT = B (ie, the lender chooses not to offset the teaser by charging … Buser, SA, Hendershott, PH, and Sanders, AB "Pricing Life of Loan Rate Caps on Default-Free …

Institutional disparities in the pricing of adjustable rate mortgage loansInstitutional disparities in the pricing of adjustable rate mortgage loans
link.springer.com [PDF]
… Tests of the pricing of California ARM teasers when base rate is held constant, 1989 (dependent … 3) and assuming BT = B (ie, the lender chooses not to offset the teaser by charging … Buser, SA, Hendershott, PH, and Sanders, AB "Pricing Life of Loan Rate Caps on Default-Free …

Evaluating the interest-rate risk of adjustable-rate mortgage loansEvaluating the interest-rate risk of adjustable-rate mortgage loans
www.aresjournals.org [PDF]
… Tests of the pricing of California ARM teasers when base rate is held constant, 1989 (dependent … 3) and assuming BT = B (ie, the lender chooses not to offset the teaser by charging … Buser, SA, Hendershott, PH, and Sanders, AB "Pricing Life of Loan Rate Caps on Default-Free …

Mortgage product substitution and state anti-predatory lending laws: better loans and better borrowers?Mortgage product substitution and state anti-predatory lending laws: better loans and better borrowers?
link.springer.com [PDF]
… Tests of the pricing of California ARM teasers when base rate is held constant, 1989 (dependent … 3) and assuming BT = B (ie, the lender chooses not to offset the teaser by charging … Buser, SA, Hendershott, PH, and Sanders, AB "Pricing Life of Loan Rate Caps on Default-Free …

The economics of structured financeThe economics of structured finance
www.aeaweb.org [PDF]
… Tests of the pricing of California ARM teasers when base rate is held constant, 1989 (dependent … 3) and assuming BT = B (ie, the lender chooses not to offset the teaser by charging … Buser, SA, Hendershott, PH, and Sanders, AB "Pricing Life of Loan Rate Caps on Default-Free …

Securitization: cause or remedy of the financial crisis?Securitization: cause or remedy of the financial crisis?
papers.ssrn.com [PDF]
… Tests of the pricing of California ARM teasers when base rate is held constant, 1989 (dependent … 3) and assuming BT = B (ie, the lender chooses not to offset the teaser by charging … Buser, SA, Hendershott, PH, and Sanders, AB "Pricing Life of Loan Rate Caps on Default-Free …



Q&A About Teaser Loan


How do you describe teaser loans that offer discounted index rates?

Teaser loans that offer discounted index rates are called "teaser rate" (usually in the first year).

What should you understand about which interest rate applies after the teaser rate expires?

You should understand that you will pay more in total if you take out a loan with a low teaser rate and then switch to another lender when your initial low-rate period ends.

How can teaser loans help save borrowers money on interest costs?

Teaser loans can help save borrowers considerable amounts of money on interest costs because they have lower rates during their introductory periods.

What is a teaser loan?

A teaser loan, also called an adjustable rate mortgage loan, is where the interest is paid at a very low rate by the borrower, which eventually accelerates after a few years.

Which interest rate applies after the teaser rate expires?

The regular, higher, interest rate applies after the teaser rate expires.

How can you comprehend how teaser rates affect borrowers payment?

Lets assume Bank A offers 1, ARM to Jack. The interest rate charges I prime plus at 5 and a cap of 1. If the prime rate is at 3 then Jacks interest would be 5 plus 3 and at 8 and makes the monthly payment at 733.77. Now say, the prime rate increases to 4 then the loans interest rate would increase to 9, increasing the payment to 84.63 In most cases, ARMs will have caps on how high or how low they can go in a year quarter month and how much they are free to move as well but in some cases it might be that only if its in upwards trend that means borrowers will be no luck if their interest rates fall so this concept of teaser loan acknowledges risk both lenders and borrowers will benefit if their interests favorably change thus ARMs are complex to deal with for this reason borrower needs read understand documents provided by lender borrower need sure they can handle them Borrower need sure they can handle them so must read understand documents provided by lender must read understand documents provided by lender must read understand documents provided by lender must read understand documents provided by lender must read understand documents provided by lender must read understand documents provided by lender must read understand documents provided by lender """""""""

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