July 20, 2024

What Is A Discounted Mortgage? – Forbes Advisor UK

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A discounted rate mortgage is a variable rate mortgage where the interest can rise or fall from month to month. Find out more about how discounted rate mortgage deals work, and the pros and cons, in our guide.

What is a discounted rate mortgage?

A discounted rate mortgage is a home loan where the rate is variable, not fixed. The rate borrowers pay is represented as a discount off the lender’s standard variable rate (SVR). All mortgage lenders have an SVR or an equivalent (at Nationwide building society for example, it’s called the SMR or Standard Mortgage Rate). The SVR is the rate that borrowers revert to after a fixed rate, tracker rate or discounted rate deal comes to an end. Effectively it is the lender’s default mortgage rate.

How does a discounted rate mortgage work?

A discounted variable rate mortgage comes with a variable or floating rate that can rise or fall from month to month.

The discount is set by the lender and will usually be a percentage discount off its SVR. To give an example, if a lender’s SVR is 7.5%, a typical discounted rate mortgage might be 2% below SVR for two years. This would give a starting pay rate of 5.5% on the deal.

However, if interest rates rise and the lender decides to increase its SVR, the borrower’s mortgage rate will also rise. If the lender increased its SVR from the example above to 8%, the new pay rate on the discounted mortgage would be 6% (the 2% discount off SVR stays the same). Conversely, if rates fall and the lender lowers its SVR, the rate on the discounted deal will also fall.

What are the advantages of a discounted rate mortgage?

The main advantage of discounted rate mortgage deals is that borrowers tend to benefit when interest rates fall. Homeowners who feel we are at the top of an interest rate cycle may decide to take a discounted rate in the hope that rates will come down. In contrast, borrowers on fixed rate mortgage deals can’t benefit from falling interest rates during the term of their deal.

What are the drawbacks of a discounted rate mortgage?

It is possible to get a competitive deal with a discounted rate mortgage, but there are some downsides to consider:

  • The variable mortgage rate is likely to go up if interest rates rise
  • There may not be a ceiling on how high the mortgage rate could rise
  • Some discounted rate deals have a floor, sometimes known as a ‘collar’, this is a rate below which the mortgage rate can’t fall (so borrowers could miss out when interest rates fall to very low levels)
  • Variable rates can make it harder to budget because you don’t know what might happen to rates, and monthly mortgage payments, in the future.

Should I choose a fixed or discounted rate mortgage?

There are many factors to consider when choosing between a fixed rate and a discounted rate or variable mortgage rate deal. Overall the decision will come down to your own personal and financial situation and how you feel about the risks attached to variable rates, and how much flexibility you have in your monthly budget (to absorb any increase in rates).

A fixed rate offers peace of mind that your mortgage payments won’t change during the term of the deal, such as two years or five years for example. A fixed rate is a form of insurance policy against rising rates. But in a falling interest rate environment, borrowers won’t benefit from lower rates while they are on a fixed rate deal.

If borrowers are comfortable with taking some degree of risk with a variable rate, a discounted rate deal can have a competitive starting pay rate, while offering borrowers the change to benefit from sliding rates. However, variable rates can make budgeting difficult as the amount you pay each month can vary if and when interest rates change.

At the time of writing (December 2023) some of the most competitive two- and five-year fixed rate deals were cheaper (based on lower starting pay rates) than equivalent discounted rate deals. For borrowers looking to keep costs low from the outset, this could be another consideration.

What happens at the end of the discounted rate period?

At the end of the discounted rate deal, whether it’s a two, three, or five-year deal, for example, the mortgage rate will revert to the lender’s standard variable rate (SVR).

This will usually be a significant jump in rate meaning much higher monthly mortgage payments. Most borrowers will look to remortgage to a new mortgage deal, such as another discounted rate, tracker or fixed rate deal, before they move onto SVR, to take advantage of more attractive rates.

Alternatives to discounted mortgages

  • Fixed rates: with a fixed rate mortgage deal the rate will not change for the duration of the deal. Popular fixed rate terms include two-years, three-years and five-years. There will usually be early repayment charges (ERCs) if you want to leave a fixed rate deal before the end of the term.
  • Tracker rates: a tracker rate mortgage is a type of variable rate deal, but instead of the rate being linked to the lender’s standard variable rate (SVR) it is linked to the Bank of England Bank Rate.
  • Standard variable rate (SVR): this is the lender’s default mortgage rate. All mortgage deals revert to a lender’s SVR when they come to an end, unless the borrower remortgages to a new deal.

    SVRs tend to be much higher than the best fixed, tracker and discounted rate deals available. Currently they are averaging between 7% and 8%. However, SVRs offer flexibility because there are no penalties to move from SVR to a new deal. By contrast, discounted and fixed rate deals usually carry early repayment penalties if you want to leave the deal before the end-date.

    SVRs can be a good short-term option for borrowers planning a house move, for example – or for those with a very small outstanding loan where an arrangement fee to take a new mortgage deal may not be worth paying.

Is now a good time to take a discounted rate mortgage?

In light of continued falling inflation, mortgage experts and pundits believe we are at the top of the interest rate cycle (December 2023), after almost two years of consistent interest rate rises by the Bank of England.

It means that the next move by the Bank of England could be to reduce interest rates. That said, any reduction may not come until late in 2024. And there is the added caveat that nothing is guaranteed and if inflation – which has been falling – started to rise again, rates could take a different path.

Whether now is a good time to take a discounted rate mortgage depends on your attitude to risk and the flexibility in your budget to deal with potential increased costs, should they happen.

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Frequently Asked Questions (FAQs)

How do I find the best discounted rate mortgage deals?

The quickest and easiest way to search for competitive discounted rate deals from across the market is to use an online mortgage search, such as our tool powered by our mortgage broker partner Better.co.uk.

You can put your specific mortgage parameters into the search, such as whether you’re a homebuyer or looking to remortgage, the value of the property and the mortgage size you need, and it will scour the market for the right deals to suit your needs.

Are there fees attached to a discounted rate mortgage deal?

The most competitive discounted mortgages will usually come with arrangement fees. These can typically range from around £300 up to £1,500, depending on the deal and the lender.

When calculating the total cost of a mortgage deal it is important to factor in the fees as well as the overall rate.

In addition to this, discount mortgage deals tend to carry early repayment charges (ERCs) if you want to leave the deal or repay the debt in full before the end of the term.

ERCs can be high and may be a percentage of the outstanding balance, for example up to 5% of your loan.

Can I switch from a discounted to a fixed rate?

Borrowers can leave a mortgage deal at any time, but there may be early repayment penalties to pay. If switching is something you may need to do – for example in the event interest rates rise significantly and you’ll want to fix – check the terms and conditions so you know what you’d have to pay in early redemption charges.

Some lenders offer more innovative tracker or discounted rate deals that come with the option to switch onto a fixed rate at a later date with no penalty. A premium is likely to apply to gain this flexibility, however and choice will be limited. If this is something you might be interested in, speak to an independent mortgage broker.

Can I keep my discounted rate mortgage if I move house?

Most mortgage deals are portable, which means you can take your mortgage with you if you buy a new property, subject to the lender’s terms and conditions. If you’re buying a more expensive property and need to borrow more, this extra mortgage borrowing must usually be taken out on a new mortgage deal with the same lender.

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