A discount mortgage is essentially a home loan where the interest rate is set at an amount below the lender’s standard variable rate (SVR). This could be for either a set period (two or five years) or for the whole mortgage.
The SVR is an interest rate set by your lender, which it can raise or lower by any amount, at any time. Over the long-term the SVR tends to move broadly in line with the Bank of England’s base rate (but is higher than it).
A discounted mortgage is a type of variable-rate mortgage, meaning the amount you pay can change from month to month.
When you repay your mortgage, part of the money goes towards the interest charged by your lender and the other part towards repaying the money you’ve borrowed.
The saving you make on a discount mortgage only applies to the interest that you pay.
Say a lender has an SVR of 6% and the discount is 1%, the interest rate you will pay is 7%. If your lender raised its SVR, let’s say to 7%, your discounted interest rate would also rise, in this case to 6%.
If your interest rate increased, your monthly mortgage payments would go up too but you would be paying more interest, rather than repaying more of the money you’d borrowed.
Discount mortgages are not directly affected by the Bank of England base rate. Instead, they always mirror the lender’s SVR, which can go up or down at anytime. However, lenders typically (but not always) increase their SVR shortly after an increase in the base rate, or decrease it shortly after a decrease in the base rate. So discount mortgages are likely to be indirectly affected by the base rate.
Trackers and discount mortgages are often classed as virtually the same thing, with discount mortgages being marginally cheaper. The difference is that a discount mortgage follows your lender’s SVR, rather than the Bank of England base rate.
To decide which of these options you should choose, you’ll need to work out whether you’re prepared to risk your lender putting up the rate in return for the savings offered with a discount mortgage or if you’d rather pay marginally more in order for your interest rate to be pegged to the base rate with a tracker mortgage.
You may prefer a tracker deal because it is possible to make an educated guess about when the Bank of England base rate is going to change, while it can be almost impossible to tell when a lender will change its SVR.
Discount mortgage deals are usually offered for somewhere between two and five years. The longer the discounted period, the smaller the discount tends to be.
When this timeframe comes to an end, your lender will usually transfer you onto its SVR automatically. This means that your monthly repayments will increase, as you’ll be paying a higher rate of interest. At this point, you should think about remortgaging to find a better new deal.
As with any mortgage, you need to ask yourself a few key questions, such as –
It’s a good idea to use a mortgage calculator to get an idea of how much you can borrow, according to your salary. This will help you to work out the price range of houses.
This refers to the proportion of your home that you own outright, without a mortgage.
Let’s say someone is buying a £100,000 house with a £25,000 deposit, meaning they have 25% equity. Therefore, the more equity you have, the lower your mortgage rate will be.
Most first-time buyers have a mortgage term of 25 years or more, although their initial interest rate is likely to only last two, three or five years. This means the entire debt will be paid off at the end of the full (e.g. 25-year) period. In reality, most homeowners these days switch to a new mortgage every few years to keep costs as low as possible.
But generally speaking, with any loan, it’s preferable to go for the shortest term you can confidently afford. That way you pay less interest and clear the debt quicker.
When choosing the type of mortgage for you, have a play with a mortgage calculator to see if you could afford the monthly payments if a discount mortgage went up.
This is really important because if a discount mortgage would already stretch your monthly budget to the max, you should borrow less and consider a fixed-rate term for greater peace of mind.
But some of the very cheapest mortgages have huge fees that can run into thousands of pounds.
In these cases, it may be better to do your homework and opt for a mortgage with a higher interest rate, but one with lower fees.
Mortgages come with a variety of fees that you need to pay attention to.
Often, a lender will advertise a rock-bottom interest rate to draw in customers, but they’ll rack up the fees to ensure they aren’t making any less money on the deal.
Below are the main bulk of fees to watch out for:
This is the lender’s charge for the administration of setting up your mortgage. These have crept up in recent years and some can be as much as £2,000.
You don’t always have to pay for this upfront as it can be added to your mortgage. But just bear in mind that this means you’ll pay interest on it, increasing the overall cost of your mortgage in the long run.
If you want to leave your deal early many lenders will penalise you. You’ll also trigger a penalty if you pay off your mortgage entirely and, sometimes, if you try to overpay.
The penalty can be calculated in a variety of ways:
This is perhaps the most important charge to check. Many lenders charge a fee to close a mortgage when you’ve paid it off.
Despite brokers estimating that it costs lenders around £50 to close off a mortgage, this fee has risen in the last couple of decades, with some mortgages carrying a £200 fee.
The regulator has stated that lenders should not profit from this fee, although it is yet to act against those charging large amounts.
Make sure you check what you’ll pay before you accept a mortgage offer. It’s possible it may be masquerading under another name too, so look out for a “deeds fee”, “discharge fee”, “redemption fee”, “sealing fee” or “vacating fee”. Learn more about exit fees.
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