Pay Rate vs. Teaser Rate

If you scan through mortgage programs and lender rate sheets you may have come across mortgage lingo such as “pay rate” or “teaser rate”.

Though the two terms are sometimes used interchangeably by loan officers, mortgage lenders, and mortgage brokers, they are actually very different. Allow me explain why.

What Is a Pay Rate?

  • A payment option offered on certain home loans
  • That allows you to pay less than the note rate
  • But this typically means the interest isn’t paid in full
  • Which results in negative amortization

A “pay rate” is essentially an option to make a mortgage payment that is lower than the actual note rate (mortgage rate) associated with the home 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 each month to cover the total amount of interest due, and the unpaid portion will be tacked onto the existing loan balance.

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For example, if you owe $1,000 in interest in a given month, but the lender gives you the option to only pay $800, that $200 shortfall would be added to the outstanding balance going forward.

So you don’t actually get a discount, you get a payment deferment, which will actually cost you because the loan balance will grow, resulting in more interest on subsequent payments.

Of course, it can serve a meaningful purpose if you have cash flow issues, or if you simply want to allocate your liquidity elsewhere.

But 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 and what happens with the shortfall.

Tip: Pay rates are usually associated with those 1% option-arm loans everyone is angry about.

How Is a Pay Rate Different Than a Teaser Rate?

  • A teaser rate actually provides a discount for a set amount of time
  • Typically during the beginning of the loan term
  • The discounted interest rate means less interest is due
  • But that payments are still made in full each month during the promotional period

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!” Or something similar.

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, it’s more like a fixed start 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 rate adjustments in a rising interest 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.


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