Mortgage Guides

Discount mortgages

By Becca Talbot becca@consumerchoices.co.uk

What are the advantages and disadvantages of discount mortgage, and who might they suit? (Updated 18/9/09)

As the name implies, discount mortgages give you a discount off a lender’s standard variable mortgage rate, which means you’ll have more money available at the outset.

This guide will explain everything you need to know about discount mortgages, how they work and the advantages and disadvantages you need to be aware of before taking out a mortgage.

• What is a discount mortgage?
• The difference between a discounted mortgage and a tracker mortgage
• The advantages of a discount mortgage
• The disadvantages of a discount mortgage
• Who would a discount mortgage suit?
• Our recommendations

What is a discount mortgage?

A discount mortgage is a variable rate mortgage, with an initial rate of interest that is discounted a set amount below the lender’s standard variable rate (SVR), for a specified time period. After the discount period ends customers are usually moved onto their lender’s SVR.

For example, if a lender’s SVR is 4.7% and the discount is 1.5%, the interest rate you’ll pay is 3.2% for the specified period, provided the SVR stays the same. Read the key facts illustration closely before signing up to a discount mortgage though, as some have a “stepped discount,” where the discount decreases in two or three stages during the specified time period.

With most discounted mortgages, the cheaper rate applies for two or three years, although longer deals are available. As a general rule, the bigger the discount, the shorter the period for which it applies.

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The difference between a discounted mortgage and a tracker mortgage

Tracker and discount mortgages are both types of variable rate mortgage, where the interest rate will usually fluctuate during the mortgage term. However they are not the same product.

If you have a tracker mortgage, the interest on the capital you borrow will be set at a fixed margin above the Bank of England base rate, and will therefore change in line with interest rate changes. For example, if you have a tracker that is 2% above the base rate, with the base rate at 0.5% you will be paying back your mortgage at a rate of 2.5%.

A discount mortgage however, works slightly differently. Rather than being tied to the Bank of England base rate, the interest rate you pay depends on your lender’s standard variable rate (SVR). Lenders will often change their SVRs if there is an increase or decrease in the base rate, but they don’t have to, and any changes are at their discretion.

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The advantages of a discount mortgage

• You get a fixed period of discount – normally two, three or five years
• You should benefit from lower monthly repayments if interest rates fall, but remember a discount mortgage is tied to the lender’s SVR so doesn’t necessarily have to reflect changes in the base rate.

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The disadvantages of a discount mortgage

• Discount mortgages often come with early repayment charges (ERCs) for a certain amount of time. This means that if you are within the ERC period, you will have to pay the penalty if you want to pay off or switch your mortgage
• If interest rates fall, lenders will pass on the cuts to those on tracker mortgages, but not necessarily to those on discount mortgages as these are tied to the lender’s SVR. If they don’t lower their SVR then discount mortgage customers could end up paying more than other variable rate customers
• With any variable rate mortgage it can be more difficult to budget in the long-term because your payments can change.

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Who would a discount mortgage suit?

Historically, discount mortgages were ideal for first-time buyers, who could used the reduced interest payments to help them afford furnishings for their new homes.

Nowadays, if you can find a lender with a low SVR, a discount mortgage can be a cheaper option for borrowers who are prepared to take the risk that their lenders’ SVR may fluctuate. Anyone thinking of taking out a discount mortgage needs to consider whether they will be able to keep up with repayments in the event of an interest rate rise though, as this could really push up the monthly costs on a large mortgage.

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Our recommendations

With the cost of living on the rise and the base rate at a historically low level, we are currently in a period of financial uncertainty. During this time many people will prefer the security of a fixed-rate mortgage rather than a variable rate mortgage. If you don’t want to risk being hit with rising interest rates you should probably choose a fixed-rate mortgage.

However, if you are considering a variable rate mortgage, then a discount mortgage could work out as a cheaper option in the long-term, as you’ll be paying less than your lender’s SVR.

Before you apply for any mortgage though, you need to consider:

• How long you are prepared to be tied in for
• How much you can afford to repay monthly
• How much you can afford as a deposit
• How much the arrangement fees are
• Whether or not early repayment charges apply.

An independent mortgage broker will be able to help assess your financial situation and choose a product that best suits your needs.

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