In this article, we explain what a discount mortgage is, how it works and the pros and cons of choosing a discount mortgage. We also explain the best way to get help and advice to ensure you are getting the right mortgage for your circumstances.
What is a discount mortgage?
A discount mortgage or discounted variable mortgage is a type of mortgage that offers a set discount to the lender's standard variable rate (SVR) for a fixed period of time, known as the deal period. As such a discount mortgage is a type of variable rate mortgage, as the rate will fluctuate each time the lender changes its SVR. This means that your monthly mortgage payment may go up or down during the deal period. For example, if the lender's SVR is 5% and your rate of discount is set to -2%, you will pay 3% interest on your mortgage loan.
If you do not like the idea of your mortgage payments changing throughout your deal period, then you may be better off exploring a fixed-rate mortgage instead. If you would prefer for your interest rate to simply track the Bank of England base rate, you should explore a tracker mortgage. If you require help and advice on the best type of mortgage for you then you should contact an independent mortgage specialist* who will search the mortgage market on your behalf and provide guidance at no extra cost to you.
What is a 2-year discount mortgage?
A 2-year discount mortgage deal is one where the interest rate is set at a discounted level below the standard variable rate for a period of 2 years. Similarly, a 5-year discount mortgage is one that offers a discounted rate for a period of 5 years. Should you wish to switch your mortgage deal or move house during the fixed discounted period, you may be required to pay an early repayment charge, so it is a good idea to check the terms and conditions to see how much your lender charges. Shorter fixed terms on a discount mortgage are likely to offer a larger discount than those over a longer term.
What is a lifetime discount mortgage?
A lifetime discount mortgage is where the discount to the lender's standard variable rate applies for the life of the mortgage, rather than for a set fixed term, such as 2 or 5 years. Lifetime mortgages usually require extra consideration as they are a long term commitment.
How does a discount mortgage work?
A discount mortgage charges an interest rate that is based on a set discount to the lender's standard variable rate (SVR). The discount is agreed at the outset and is usually fixed for a predetermined number of years - normally 2 or 5 years. Although the level of discount will not change during the fixed period, the SVR can fluctuate. This is often as a result of changes to the Bank of England base rate, however, a lender is free to change the SVR as they see fit.
Below is an example of how a discount mortgage rate works:
|Lender's variable rate||Discount rate||Variable interest rate you pay|
In the example above, the borrower would pay 5% minus 2% which equals 3% interest on the loan amount that they borrowed. But, should the lender change the standard variable rate our interest rate would change accordingly. This means that the interest rate that you pay could go up or down and your monthly mortgage payment would change too.
Can a discount mortgage change during the fixed deal period?
Yes. The interest rate can change during the fixed deal period of your discount mortgage, as well as the amount you repay each month. This is because the interest rate you pay is discounted rate based on your lender's standard variable rate (SVR). So, if your lender changes its SVR, the interest you pay will change and this will affect the amount that you pay each month for your mortgage.
Pros and cons of a discount mortgage
- You will pay less than the standard variable rate charged by your lender during the fixed deal period
- You could benefit from interest rate reductions if your lender reduces its standard variable rate
- The early repayment charge applied for switching mortgages mid-deal may be lower than the equivalent for a fixed-rate mortgage deal
- While the discounted deal period may be fixed, interest rates and repayments can fluctuate as the discount is applied to the lender's standard variable rate
- You may not benefit if your lender reduces its standard variable rate, as it may apply a 'collar', which can limit interest rate reductions
- If your lender increases its standard variable rate your interest rate will also increase making your monthly mortgage repayments higher
Is a discount mortgage a good idea?
A discount mortgage can be a good idea in an environment when SVRs are low as you will secure a low rate of interest. However, SVRs are not fixed, meaning your interest rate will increase every time your lender increases its SVR. On the other hand, one of the key advantages of a discounted mortgage is that you could benefit from an even lower interest rate should your lender decide to reduce its SVR. You should check the terms and conditions of any discounted mortgage deal as there is usually a 'collar' applied to how low your interest rate can go, so even if the SVR drops, you may not benefit from better rates and lower repayments. Conversely, lenders rarely apply a 'cap' to the amount of interest you pay so if the SVR soars, there may be no way to prevent your interest rate from increasing with it.
How to choose the right mortgage for you
Arranging the right mortgage for your particular circumstances is important. You should weigh up the pros and cons of each type of mortgage in order to work out which one suits your needs best. If you would prefer for your mortgage repayments to be the same each month then a discount or tracker mortgage is unlikely to suit you. However, if you are comfortable with changes to your monthly mortgage repayment and are happy to accept that your mortgage repayments are likely to fluctuate, then a discount mortgage or tracker mortgage may be right for you. If you simply prefer to know exactly how much you will need to repay each month on your mortgage then you may be better off looking at a fixed-rate mortgage deal. For the latest insight into what is likely to happen to interest rates in the coming months, check out our article, "When will interest rates rise (or be cut)?".
Arranging the right mortgage solution requires you to make a number of decisions. You will need to select the type of mortgage, how your interest rate is applied and how long you want to be locked into your deal. Some of your choices will depend on what mortgage deals are available and affordable to you - others will depend on your preference. Making the right choices can be complicated as the mortgage market is vast making it difficult to compare mortgage deals.
Lenders all have different acceptance criteria and each uses different affordability measures to decide if they can make you a mortgage offer. For this reason, it is wise to get a mortgage broker on your side so that they can guide you through your options. Mortgage brokers often have access to mortgage deals that are not directly available to borrowers and their in-depth knowledge will help you to find the right mortgage deal.
If you don't have a mortgage broker, consider contacting Habito*, an online mortgage broker with access to over 20,000 mortgage deals from around 90 different lenders. Habito does not charge a fee for its services and is a quick and efficient way of getting mortgage help. Alternatively, you can search for a mortgage broker in your local area based on reviews from other mortgage customers using the website, VouchedFor*.
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