Interest rates
Discounted Rate Mortgages
With a discounted rate mortgage, the Standard Variable
Rate of a lender is temporarily reduced by a set amount
for a specified period, usually from one to five years.
Once the discounted period is over, borrowers then revert
to paying the prevailing Standard Variable Rate.
With this type of mortgage, it is the discount that is
fixed and not the actual rate payable. An example is a rate
that is guaranteed to have a 1.75% discount from the SVR
for 3 years. If the Bank of England base rate rises or falls
and the lender follows suit with their own SVR, your discounted
rate will also change accordingly.
It is quite common to find mortgages with a number of steps
in the discount. You may find that you start out paying
a significantly reduced rate for six months. The discount
is then reduced, so your rate rises slightly. Following
a second period of a lesser discount, the rate usually reverts
to the SVR, but there may even be a third step in the discount
before doing so.
Advantages
Some of the most competitive initial rates are to be found
with discounted mortgages. The discounts can be quite substantial,
with introductory rates as low as one or two percent far
from uncommon. This can be incredibly useful if you are
going to have a lot of other expenses once you have bought
your house.
The initial rate is often slightly lower than with an equivalent
fixed rate product, since the lenders has the security of
knowing they will be able to charge you more interest if
the Bank of England raises interest rates.
Finally, with a discounted rate of interest, you can benefit
from a fall in the base rate - unlike a fixed rate, you
will enjoy lower repayments when the lender lowers their
SVR.
Disadvantages
Unlike a fixed rate, you don't have any control over how
high your rate can go. There is nothing to say that the
MPC won't make half a dozen rate increases within a 12 month
period, and if base rates start to spiral, your interest
rate will be sure to follow soon after.
The heavier the discounts, the more severe payment shocks
when the discount period ends and the monthly repayments
jump by a large amount to match the SVR. You must be sure
that you can budget for this in your monthly expenses.
Discounted mortgages almost always have heavy redemption
penalties for the duration of the discounted period. The
penalties can be stepped as well as the discount, so that
you get added punishment if you wish to change your mortgage
during or immediately after the period of greatest discount.
As with fixed rate mortgages, the early redemption penalty
can overhang the duration of the discount period, especially
with those products with extremely competitive initial discounts.
