To understand discount rate mortgages, you first have to understand about Standard Variable Rate (SVR) mortgages.
This is because a discount mortgage is simply a rate which offers a discount on the lender’s SVR.
When you take out a new mortgage deal, it will last for a set period, such as two, three or five years. During this period, you’ll probably have to pay large penalties if you want to switch to a new deal.
Once this period ends, however, you’ll probably be automatically moved onto your lenders’ SVR (although some deals now revert to lifetime trackers). At this point you can switch without paying any penalties.
Most SVRs tend to be around 2% higher than the most competitive deals available on the market, but double-check what yours is because it can vary from lender to lender.
The most important point to bear in mind is that the SVR is entirely within the control of the lender. The lender can decide at any time to increase or decrease this rate. It is not in any way tied to the base rate, although as a general rule, lenders tend to increase their SVRs when the Bank of England increases the base rate. Many also decrease their SVRs when the Bank of England decreases the base rate, but this is in no way guaranteed and cuts may not be passed on in full.
How big is your discount?
If your lender’s SVR is 6%, and your discount is 2%, then your current mortgage rate will be 4%.
However, a discount mortgage is a variable rate mortgage. So the rate can vary throughout the deal. The upside of this is that it can go down, meaning lower monthly payments, but the downside is that the rate can go up, meaning higher monthly payments. And remember, you are likely to be tied in to the deal, so will have to fork out heavy penalties if you want to switch to a new deal because your rate has increased.
So you must be prepared to take the risk that the rate can increase, and have enough slack in your budget to cope with any possible rise. If you don’t, you should opt for a fixed rate instead.
Discounts vs trackers
On the surface, discounts and trackers look very similar. Both are variable rates. But you’ll often find a discount is slightly cheaper than a tracker. Why is this?
It’s because, with a discount, you’re relying on the lender to pass on any cuts in the base rate by making an equivalent cut in the SVR.
This is a risk you do not have to take with a tracker. A tracker transparently tracks the base rate, so any fall in the base rate must immediately be passed on – just as any rise must.
For this reason, a discount is slightly less attractive than a tracker, and therefore is often priced at a cheaper rate.
Whether you think it’s worth paying more for the transparency of a tracker is up to you, but be aware than very few lenders passed on all the base rate cuts in 2008 to customers on their SVR.
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