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How Do Discounted Mortgages Work?
A discount mortgage works like a variable rate mortgage, except you receive an initial discount. Each mortgage lender has a standard variable rate (SRV) that determines your mortgage interest rate. This standard variable rate is normally 2-5% higher than the Bank of England base rate. The lender’s SRV can go up or down for several reasons, causing your mortgage interest rate to regularly change.
With a discount variable rate mortgage, your interest rate is fixed at a set percentage below the SRV. Just as the SRV goes up and down, the discounted interest rate will also go up or down, but will always be below the SRV. So, your monthly payments could still change with a discount mortgage.
Discounted mortgages are appealing as, while the SRV is likely to change, at least you’re paying less than the lender’s standard variable rate.
However, once the discount mortgage period ends, you’ll switch to the standard SRV and have to pay higher interest rates.
How are discount mortgages calculated?
Your discount mortgage will be offered to you as a percentage. For example, you might be offered a mortgage with a discount of 1%. If the lender’s SRV was set at 5%, then you’d only have to pay an interest rate of 4% with the discounted mortgage.
How long do variable rate discounted mortgage deals last?
Typically, the discounted period lasts between 2 and 5 years. However, this depends entirely on the type of deal the lender is offering at the time in which you apply. It also depends on your credit score, affordability checks, and other financial assessments that the lender will carry out.
Once the discounted variable rate ends, you could potentially apply for another discounted rate. Or, the lender may offer you an alternative low-rate deal.
It is possible to get lifetime discounted mortgages from certain lenders. In this case, you’d receive a discount for the entire duration of your mortgage repayments. However, the longer you’re offered a discount, the smaller the discount percentage you’ll likely get.
Discount Mortgages vs Tracker Mortgages
A tracker mortgage is another example of a variable rate mortgage and works similarly to that of a discounted mortgage. The main difference is that a tracker mortgage directly tracks the Bank of England’s base rate, while a discounted mortgage tracks your lender’s SVR. Discount rates tend to offer slightly better interest rates.
However, with a tracker, it’s much easier to predict when interest rates will rise. It’s linked to a publically available base rate, so tracker loans can be said to be more transparent than discount mortgages.
On the other hand, both tracker and discounted mortgages are known to charge less in early repayment fees than other mortgage types.
Advantages and Disadvantages of a Discounted Mortgage
Advantages
- You don’t need to pay as much interest as those on standard mortgage deals. This allows you to budget better, at least during the initial years of your mortgage.
- Discounted mortgages also tend to come with lower early repayment fees. This means that you can choose to pay off your mortgage deal early without suffering severe repercussions.
- Having this discount in place, you have a slight market advantage during market uncertainty. At least your monthly repayments won’t be as high as they could be.
Disadvantages
- The standard variable rate (SVR) can go up unexpectedly. While you’ll still get a discount, perhaps your discounted variable rate will be at the level the SVR was formally at. While you’re still getting a discount, your interest rates can still be high.
- There’s no real peace of mind with a discounted variable mortgage. Your mortgage interest rate could change unexpectedly, leaving you with a significant bill to pay one month, and then a smaller bill to pay the next.
- Some lenders impose a cap on how much your discount rate can fall. This puts a limit on how much you can save with a discounted variable mortgage.
FAQs
How much will a discount mortgage save me?
The amount a discount variable mortgage can save you depends entirely on the size of the mortgage as well as the percentage offered by the lender. A discounted variable mortgage will definitely save you more money than a standard variable rate mortgage offered by the same lender.
Are discount mortgages variable or fixed rate?
Discounted mortgages are always variable, meaning that the discount mortgage rate can differ from month to month. You won’t find a discount fixed rate.
Can I use a discounted variable rate mortgage when remortgaging?
Yes, it is possible to get a discount variable mortgage when remortgaging your house. However, the discount you save on interest may be offset by the amount you’ll have to contribute towards your early repayment fee for your current mortgage.
Final Thoughts
If your lender’s SVR remains low, your discount mortgage could work out in your favour. Your monthly repayments will remain low throughout the agreed mortgage deal period, which could save you a good amount of money. However, if the lender’s SVR shoots up dramatically, your discount rate will, too. This will result in you paying more for your interest, saving you little money.
So, discounted mortgages are sometimes not worth the risk. For better peace of mind, a fixed-rate mortgage will ensure that you pay the same rate in interest each month.
Additional Sources:
https://www.totallymoney.com/mortgages/discount-mortgages/
https://www.moneysupermarket.com/mortgages/discounted-variable-rate-mortgages/