Beware of Honeymoon or Introductory interest rates

Beware of Introductory or “Honeymoon” Interest Rates Offers:

I recently saw a bank advertising a fixed rate of 2.99%. No other details. Simply titled;

“How does a 2.99% fixed rate loan sound?”

This prompted me to follow up on my post in March on Comparison Rates and advise on what is, in my experience, normally a trap.

What are introductory rates?

An introductory rate is one where typically the rate is cheaper for the first year or two of the loan term.  Once the honeymoon period is over the interest rate will rise.

Why should I avoid Honeymoon rates?

All banks have to pay their shareholders or members and therefore, if they are not making money off you in the first year (the honeymoon year) then they need to make their money off you in the following years.  To ensure they do this, once the initial honeymoon period is up the interest rate will rise considerably (normally over and above the standard rate you would normally be entitled to).  Further, to stop you from then refinancing either internally or to another bank, they contract you to a 3-4 year Deferred Establishment Fee (DEF) so if you do try and exit after the cheap period they charge you a break fee which will always be more than the savings you made in the initial year or two.

Why do banks offer introductory rates?

They are great for advertising – nothing grabs the attention of the home owner than a rate 2% lower than what they are paying.  This gets those looking for a mortgage calling the bank or going into the branch to see all about this fantastic rate.  Often though, once you sit down and read the fine print (if you bother), its not worth it to take the introductory rate.  However, as you are already in the bank you end up being talked into taking one of their other products (which may or may not be the best deal for you).

How do I know if it is an introductory or “honeymoon rate”?

The best question to ask if you are trying to work out if it’s a introductory or “honeymoon rate” is – does it sound too good to be true… If the banks are all offering rates around 5% and someone comes along with a rate of 3% there is a good chance it is going to be an intro rate.

Also, check the comparison rate (see my article in March 2009) – this will be a very good indicator of whether it’s a honeymoon rate however often the early exit fee will not be included in this comparison rate so in reality its even worse!

Further information here for expats and here for temporary residents.