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What is a discount rate mortgage?

For most people, getting a mortgage is one of the most important financial decisions in their lives. When you start to look for the best mortgage, you will see hundreds of mortgage products with different names and associated mortgage deals and interest rates. As a borrower, it is important that you understand the different types of mortgages so you can choose the mortgage that is best suited for you. In this suite of mortgage guides, we look at the different type of mortgages available in the market.

Previously we discussed standard variable rate mortgages, in this mortgage guide, we will focus on variable discount rate mortgages.

A discount rate mortgage is a 'type of mortgage' that is based on variable interest rates.

Discount mortgages

With discount mortgages, mortgage lenders offer a discount on the Standard Variable Rate (SVR) for a certain period, for say two to three years. As a borrower you should review the SVRs charged by different lenders and not simply base your decision on the discount. One bank may provide a discount of 2% on an SVR of 5%, and another bank may offer a discount of 1.25% on an SVR of 4%. After discount, you will pay an interest of 4% to the first bank, and 3.5% to the second bank. So even though the first bank is providing a higher discount, you will get a better deal with the second bank.

Advantages of discount mortgages

  • You will be paying a lower rate of interest for an initial period, resulting in lower monthly repayments.
  • If there is a reduction in the SVR by the lender, it will be beneficial for you.

Example: Furness Building Society is offering a discount rate mortgage of 1.50% - SVR minus 4.04% for 2 years. So, for the first 2 years, there's a 4.04% discount on the actual SVR of 5.54%, resulting in an interest rate of 1.50% for the first two years. After two years, you will have to pay an SVR of 5.54% on the loan for the remaining term. There's an early repayment charge of 3% for the first 2 years (or the discount period).

Disadvantages of discount mortgages

  • If interest rates increase dramatically (which has happened historically), you could end up with high monthly mortgage repayments despite the mortgage discount applied.
  • Discount mortgages normally have financial caveats that make it more costly to switch mortgages before a specific term has elapsed. This is often several years after the discount has finished.

Next: Tracker Mortgages

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