That low interest rate may be too good to be true

"2.9 percent for three months!" "Your rate could be this low!" "Pay just $325 a month!"

You’ve seen the ads, but are these home loan offers a good deal?

The answer naturally depends on your personal situation, but regardless of your needs, you’ll want to be sure you understand what’s behind these offers before you accept one.

What’s a teaser rate?

Quite often, what’s behind these offers is a "teaser rate," which is a very low starting interest rate on a mortgage or other type of loan. The teaser is less than the current competitive market rate for that type of financing and is applicable for only a short time, maybe even just one month. Teaser rates can reduce housing costs in the early years of homeownership; however, the principal reason why these inducements exist is to encourage borrowers’ preferences for loans that may be more profitable for the lender.

Should you take a teaser rate?

The savings of a teaser rate might be acceptable if you intend to sell your home or refinance your mortgage, perhaps because you’ve improved your credit score, within a few years.

But if you plan to keep your home and mortgage for more than few years, that teaser rate might not be as attractive as it looks. Teaser rates that seem too good to be true invariably come with the likelihood of much higher rates and payments later just as minimum monthly payments result in deferred interest that will be added to the amount you owe and also result in much higher payments later.

Introductory ARM rates are different

A traditional conforming adjustable-rate mortgage (ARM) may come with an "introductory" interest rate for a set period of time, perhaps one month or one, three, five or even 10 years. These introductory rates aren’t true teasers, but rather are set according to pricing in the secondary mortgage market.

Introductory rates, like their teaser cousins, can be short-lived, depending on the structure of the ARM and the volatility of the underlying index to which the interest rate on the ARM is tied. Long-lasting introductory rates are unlikely to be significantly lower than the rate on a 30-year fixed-rate mortgage.

Buy-downs from your builder

Another type of promotional interest rate is a "buy-down" in which someone other than the borrower pays money to the lender to reduce the borrower’s interest rate. For example, a 3-2-1 buy-down would reduce the interest rate by 3 percent in the first year, 2 percent in the second year and 1 percent in the third year. A home builder or private home seller might offer a buy-down as an inducement to a buyer to purchase a home.

Deciding on a loan with a teaser rate

It’s difficult to evaluate and compare mortgages that have teaser and introductory rates. Always look at the annual percentage rates (APRs), good faith estimates (GFEs) and amortization schedules, as those present a clearer picture of the total cost of the loan. Ask your mortgage broker or lender to help you understand a loan offer with a teaser rate and how the loan might play out in the future. You don’t want to commit to a loan with a low interest rate, only to find that it increases 2 percent in three months.



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