Discount Mortgages: Is a Lower Rate Worth the Possible Risks?
A discount rate mortgage tracks a lender's standard variable rate, but at a discount. There are pros and cons to this sort of loan.
A discount mortgage is a type of variable rate mortgage where the lender offers you a discount on its standard variable rate for a fixed period of time, typically a couple of years. Once you come to the end of that period, you start paying the more costly SVR, unless you remortgage onto a better deal.
How do discount rate mortgages work?
All lenders set their own standard variable rate, and it's the rate you move onto at the end of any initial variable or fixed-rate period. A discount rate mortgage tracks that SVR, but at a discount. So if the lender’s SVR is set at 5%, and the discount is 2%, the interest rate on your mortgage will be 3%.
As lenders set their own SVRs, they can vary significantly: two lenders offering a 2% discount may end up charging significantly different rates. Similarly, the size and length of the discount will vary between lenders and their loans.
Pros and cons of a discount rate mortgage
The main attraction of a discount rate mortgage is that the interest rate charged is generally — but not always — lower than fixed rates on offer. With a fixed-rate mortgage, borrowers are charged a premium for the certainty in knowing precisely what their monthly repayments will be. However, increased competition in the fixed-rate market means rates have come down, so don’t assume a discount will always be cheaper.
Should you find a discount mortgage with a lower rate than a fixed, you’ll enjoy smaller repayments at the outset. However, there is far more uncertainty with a discount rate mortgage than with other types of mortgage.
With a tracker mortgage, for example, your rate follows the bank base rate set by the Bank of England, so your rate changes only when the base rate does. But with a discount rate, your rate can change at any time, as lenders can adjust their SVRs whenever they like.
It’s not just the frequency of rate changes, but the size of them too. A lender could choose to increase their SVR substantially, meaning a more significant increase to your monthly bill.
In addition, discount rate mortgages often come with early repayment charges. This is a charge you have to pay if you want to repay the mortgage early, including if you want to remortgage to a new deal. ERCs are calculated as a percentage of the sum being repaid, and so can run into the thousands of pounds. As a result, if you sign up for a discounted rate mortgage and find that the interest rate is moving higher than a level you are comfortable with, it will then cost you a significant amount to move to a different product.
How can I get a discounted rate mortgage?
Discount mortgages are less popular than fixed rates, and as a result many lenders will not offer them. You can find out what discounted mortgages are available on a price-comparison site that lets you choose which type of mortgage you would prefer.
Another option would be to consult an independent mortgage broker. They will be able to scour the market to find the best deal for you, whether that's a discount, another variable rate mortgage or a fixed rate. Your broker is also likely to have access to lenders that don’t offer their mortgages directly to borrowers and will know which lenders are most likely to accept your application.
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John Fitzsimons has been writing about finance since 2007. He is the former editor of Mortgage Solutions and loveMONEY and his work has appeared in The Sunday Times, The Mirror, The Sun and Forbes. Read more