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.

Click here to compare some of the best discounted rates available.

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 lender 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.

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