How Teaser Loans Make Up The New Market Trend

To make borrowing cheaper for the applicants. One such instrument, to appease customers, is teaser loans. This could be for any kind of loan, including a personal loan, car loan or home loan. It is a popular promotional product used to entice borrowers, as it enables loan issuers to offer customisation to their applicants.

What is a Teaser loan?

A teaser loan can be referred to as any loan that offers a teaser rate of interest. Teaser loans are a popular promotional product for loan issuers that tend to entice a broad array of borrowers. Having the flexibility to offer a teaser rate can increase customization and structuring options for all types of loans.

For example, if you opt for a home loan for a period of 30 years at an interest rate of 8%, the bank may offer you a teaser loan for which you would need to pay only 6% interest in the initial three years. In the fourth year, your interest rate will switch to 8%. Credit cards with zero or low fees, adjustable-rate mortgages, are some of the common teaser loans in the market. If you are opting for a teaser loan, you must be aware of the rate of interest that will apply after the teaser rate expires.

Further, Teaser loans can be better defined as an adjustable-rate mortgage in which homebuyers are offered loans at cheaper rates in the first two to three years. The standard rates are applied thereafter. Teaser loans can also be withdrawn after the initial term. The lower rate is an introductory offer that can be offered at a zero percent interest rate. The concept of a teaser loan was launched to attract young buyers, those who have low monthly income but can pay usual interest rates as their income rises in later years. 

Investopedia defines it as “A teaser loan can refer to any loan that offers a teaser rate of interest. Teaser loans are a popular promotional product for loan issuers that tend to entice a broad array of borrowers. Having the flexibility to offer a teaser rate can increase the customization and structuring options for all types of loans.”

How does a Teaser Loan Benefit Homebuyers?

For borrowers, this can be a win-win situation as it can be a good start for a long term mortgage like home loans. Since home loans are serious commitments, getting a loan sanctioned at a discount makes a lot of sense. However, homebuyers should also factor in their own capability to pay back the amount. For instance, what if your cash flows stop in between? Though the schemes are appealing and many developers are tying up with banks for such offers, do not go for it without evaluating the pros and cons.

The Guidelines

While the teaser loan scheme got popular in 2010, the Reserve Bank of India (RBI) laid out certain provisions to ensure fairness. Since the RBI sensed the housing bubble would burst, and the crumbling financial system would be tough to manage, they issued guidelines in 20008. These guidelines were given to banks and they were asked to increase the standard provisioning from 0.40 per cent to 2 per cent, five times the initial amount. Many banks withdrew their teaser loan schemes after these guidelines came into force. Check out the best bank for home loan from here.

However, recently State Bank of India and ICICI Bank relaunched similar schemes by tweaking terms and conditions. 

Things to Know Before Opting for a Teaser Loan

1. Teaser loans with low-interest rates help borrowers to save considerable amounts of money on interest costs.
2. Borrowers must know the rates that will apply after the teaser rate expires.
3. Borrowers should clearly understand the payment terms and requirements detailed in their loan contract, before agreeing to a teaser loan’s terms.
4. Teaser home loan products have been withdrawn in India, after the Reserve Bank of India’s (RBI’s) directive, to link all home loans with an external benchmark lending rate (repo rate).
5. The RBI has not banned teaser loans but its disapproving stance has kept lenders from offering such promotional products in India.
6. Recently, some of the big car makers have joined hands with banking institutions, to offer teaser car loans to boost car sales amid the COVID-19 pandemic.

How Teaser Loans Work 

Credit cards with 0% introductory rates are probably the most commonly known teaser loans. Adjustable-rate mortgages (ARMs) also use teaser rates to structure loans in various ways to appeal to a variety of borrowers.

Credit Cards 

Credit cards that come with 0% introductory teaser rates are among the most popular products on the market. These loans offer borrowers a maximum credit limit for borrowing with no interest charged throughout an introductory period, typically for approximately one year. Credit cards have a simple teaser rate structuring.

With a teaser rate credit card, the 0% interest rate applies for a specified period of time and then a standard rate detailed in the credit agreement—the annual percentage rate (APR)—takes effect.

Borrowers sometimes apply for a credit card with a 0% introductory teaser rate with the goal of paying off debt from credit cards with higher interest rates. The teaser rate provides them with a specified period during which to clear the debt without paying interest before a standard rate (usually the prime rate plus an additional percentage that may be based on the borrower's credit score) starts.

Adjustable-Rate Mortgages 

Adjustable-rate mortgages often use teaser rates in a few different ways. Some ARM mortgages begin with the teaser rate, which is a low promotional interest rate. This rate can be charged during all or a portion of the fixed-rate part of the mortgage. Some adjustable-rate mortgages may also use variations of teaser rates in the variable portion of the loan.

One example includes the payment options in a payment option ARM. In an ARM payment option, the borrower can choose among multiple payment choices each month, even opting to pay a lower amount (although their debt may still increase). Often, one of these choices is a payment that includes the teaser rate of interest.

Adjustable-rate mortgages also have the flexibility to structure a loan with interest rate caps that can also integrate the teaser rate concept. These loans will typically be structured as either a 2-2-6 or a 5-2-5. These numbers refer to the incremental increases that can apply at various times during the loan.

Special Considerations for Teaser Loans

Teaser loans with low interest rates can help borrowers save considerable amounts of money on interest costs. However, borrowers must also be aware of the rates that will apply after a teaser rate expires. They should clearly understand the payment terms and requirements detailed in their loan contract before agreeing to a teaser loan’s terms.

Unpredictable EMIs later

Experts say that teaser loans can deceive you into locking into cheaper rates at first, but borrowers will be in for a rude shock later if rates soar after the fixed-rate tenure has ended. A conservative borrower after paying a fixed EMI for 2-3 years may find it difficult to manage unpredictable EMIs later as it can disturb his budget.

Whether teaser loans will see the light of day or not is yet to be known.

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The conclusion to this analysis is that loan size and average loan life drives lifetime value and can compensate for an initial teaser loan rate.  Larger loans are more profitable because of the proportional lower origination and maintenance costs.  Thus, a larger loan can make up the teaser rate shortfall faster.  Also, longer maturity credits are more profitable because they offer the lender a longer stream of revenue relative to the risk which offsets initial costs and the teaser rate.  Prepayment protection on longer loans is another powerful way to increase the lifetime value of loans.

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We conclude that community banks can also take advantage of teaser rates if they properly structure these loans.  In today’s competitive lending environment and low current interest rates (but with interest rates expected to rise in the near future), selectively offering teaser rates may be an effective marketing tool and a potent way to play on the borrower psychology.

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If you’re in the market for a loan, especially a home loan, then let the experts at NoBroker help. You can be assured that they will find the best loans with the lowest interest rates for your needs. 

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