If you scan through mortgage programs and rate sheets you may have come across mortgage lingo such as “pay rate” or “teaser rate”. Though the two are sometimes interchanged by loan officers, mortgage lenders, and mortgage brokers, the two are actually very different.
A pay rate is essentially an option to make a mortgage payment that is lower than the actual note rate associated with the loan. In other words, if you only make the “pay rate” payment, which is usually referred to as the minimum payment, negative amortization will likely occur. This means you aren’t paying enough to cover the interest due, and the unpaid portion will be tacked onto the existing interest and principal.
Don’t be fooled into thinking the pay rate is a low introductory rate like those you see with 0% APR credit cards. If you find yourself with a pay rate loan, make sure you know how payments are applied. Pay rates are usually associated with those 1% option-arm loans everyone is angry about nowadays.
On the other hand, a teaser rate actually allows homeowners to pay less interest for a set period of time without accruing additional interest. Teaser rates are typically seen on home equity loans, mostly as an incentive to open one. You may see an ad for a home equity line offering “prime minus 2% for the first six months!”
What this means is that you’re actual mortgage rate will be reduced for the first six months of the loan term, and will then adjust to the standard interest rate agreed upon.
You could also argue that the starting rate on products like the 5/1 ARM have a teaser rate attached because it’s offered for an initial period before the loan can adjust higher. But technically, an ARM loan can also adjust down or simply remain flat, so it’s not necessarily a true teaser rate.
Regardless, teaser rates can save you money, but don’t choose a loan program just because it offers a special low start rate. Make sure you factor in other important aspects, such as how long you intend to keep the loan, how you plan to pay it back, and what the alternatives are.
It might be in your best interest to go with a fixed mortgage instead, even if the rate is higher at the outset. You won’t have to worry about adjustments in a rising rate environment.
And watch out for loan officers and brokers who use these two terms loosely. Over the last few years, many unscrupulous and/or uneducated loan officers were selling the pay rate as if it was a teaser rate, causing a lot of headaches, missed mortgage payments, and even foreclosures.