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Discount mortgages

Lenders offer an initial discount off their standard variable rate (SVR), which then reverts to the SVR once the set period of the discount is up. In a period of low interest rates, this can have the effect of
making a large mortgage look affordable. A 2% discount on a lender’s SVR of 5.75% means you’d pay interest at a rate of 3.75% for the period of the discount – but only as long as the SVR stayed
at 5.75%. Your mortgage rate will stay 2% below the SVR but if interest rates rise and the lender’s rate follows, your payments will also increase. And your rate will revert to the now higher SVR once the discount period ends.

Equally, of course, if rates fall, your repayments will too. This is why discount mortgages can be a
gamble and its up to you to judge how comfortable you feel with a variable rate.

DISCOUNT LENGTH

Discount mortgages vary in length from under a year to 10 years to the whole term. Deciding how long a period to go for will depend on how confident you feel about interest rates but if you’re unsure don’t go for more than two or three years.

STEPPED DISCOUNT

One problem with discount mortgages is at some point the discount will end and your payments will increase to the standard rate. If you were enjoying a substantial discount this can mean a hefty rise in repayments. A stepped discount can help soften the blow by reducing the amount of the
discount over a number of years. For example, you might start with 2%, falling to 1% after one year and to 0.75% a year after that. This means you have to budget for more gradual increases to your mortgage payments.

WHO BENEFITS?

If you have to budget, a discount mortgage probably isn’t ideal for you. This is likely to include many first-time buyers but the initially low rate of a discount mortgage can provide much needed extra cash for other expenses incurred, particularly when buying for the first time, such as furniture and decorating. However, you do need to be ready to take on a certain amount of risk. Discounted mortgages are most suitable for people who are looking for the cheapest initial payments at any given time but can afford any increased payments if interest rates rise. Likewise, if you believe that interest rates are likely to fall, or at least stay stable, a discounted mortgage makes continuing reductions to monthly repayments possible.

FEES AND PENALTIES

Discount mortgages frequently come with charges or tie-ins that prevent you from remortgaging or redeeming the loan for a set period of time. They’re not usually as severe as fees associated with fixed rates, however, because variable rates present less risk to lenders. If you need to move home or wish to increase payments during the discount period, however, this can prove expensive. It’s usually only worth paying the redemption penalty if you can make a saving elsewhere. Also, some lenders will extend the tie-in period beyond the introductory deal with an overhang period. This is an early redemption charge (ERC) that lasts beyond the discount period.

There are discounts without redemption charges, but inevitably they have less attractive rates. It’s a
question of weighing up your needs to see which of the discount deals works best for you. Discount mortgages attract borrowers with their ‘buy now, pay later’ appeal

Need to know

Source: Mortgage Advisor & Home Buyer magazine