When researching different types of finance, you will likely come across what is commonly referred to as an initial interest rate. This rate may also be called a teaser rate or an introductory rate. Although it does what it says on the tin, offering a reduced rate to attract new customers, there is more to this type of arrangement.
How do initial interest rates work?
While mortgages are perhaps more closely associated with initial interest rates than any other financial product, they are a common feature of credit cards. The world of finance is highly competitive, and many lenders are willing to give up initial interest margins to attract new custom. As a result, there are several different types of initial interest rates which are either fixed or linked to various benchmarks.
Introductory initial interest rate
As well as mortgage charges and repayments, there are numerous separate property purchase costs to consider, such as:
- Stamp duty
- Survey costs
- Estate agent charges
- Conveyancing fees
Consequently, many people seek mortgages that offer an introductory initial interest rate to reduce their outgoings in the early days. For example, the standard variable rate of the mortgage might be 3.5%, but for the first year, you may be offered a rate of just 1.5%.
Choice of initial interest rates
As we have seen in recent years, interest rates have been around historic lows for some time. But, again, if we look at mortgage finance, you may be offered a fixed rate for one year, three years or five years. Dependent upon your view of interest rates in the short to medium term, you may wish to lock yourself in for the maximum period. Consequently, you may believe that interest rates will fall within 12 months and prefer to go more short-term, refinancing after the 12 months.
Staggered initial interest rates
You will find that many mortgage arrangements are linked to benchmarks such as, for example, the Bank of England base rate. The standard variable rate might be something like the base rate plus 3%. As an introductory rate, your mortgage provider may offer:
- Base rate +0.5% for the first 12 months
- Base rate +1% for the second year
- Base rate +2% for the third year
After year three, you would revert to the standard variable rate of base rate plus 3%. With this type of arrangement, you may find minimum and maximum introductory rates to protect the lender and the borrower. For example, if the UK base rate dipped below zero, this would decimate any margin for the mortgage provider. Consequently, they may set a minimum rate of one per cent. On the flip side, there may be an upper-interest rate to protect the borrower.
Balance transfer initial interest rate
As with mortgages, the UK credit card industry is highly competitive. Credit card providers seek to poach customers from each other, offering attractive initial interest rates for balance transfers. Historically, many credit card providers offered 0% for the first 12 months on transfers, but this has changed of late. You will still see balance transfer headline rates of 0%, but numerous credit card providers have now taken to charging a fee. This could be fixed or a percentage of the balance transferred over. Remember, read the small print!
Why do lenders offer attractive initial interest rates?
Whether looking at a credit card, personal loan or a mortgage, lenders use attractive initial interest rates to grab your attention. However, once you are signed up as a customer, they may be able to sell you additional services to increase their margins. Also, when it comes to the end of fixed-rate mortgage terms, many people fail to refinance and revert to the standard variable rate.
There may be occasions when it is cheaper to remortgage elsewhere, even taking into account charges to terminate a mortgage arrangement. However, constant hopping between credit card and mortgage providers will appear on your credit file. Beware, this could impact your credit score.