Discount Mortgages - The dangers

What are the dangers of discount mortgages?

A discounted mortgage rate is exactly what it says on the tin. You benefit from a pre-determined discount from the lender's standard variable rate for a pre-determined period. This period is usually between six months and five years.

The advantage of the discounted mortgage is reasonably obvious. You can find very competitive initial rates, with some quite substantial discounts available. Some introductory rates could be as low as 1% with a large 1-year discount. Should you know that you will be lumbered with a large amount of expenses having just bought your house, these discounts could be very useful.

Another advantage of the discounted mortgage is that if base rates go down, your pay rate should get even lower. Now, it is also true that your pay rate will rise if interest rates rise, but it is this fact that makes lenders set their initial rates lower than they might do with an equivalent fixed rate product, as lenders know that if interest rates rise they can charge you more.

But there are quite a few disadvantages of discounted mortgages. In general, in return for the discount, you are likely to be tied to the mortgage for at least the period of the discount. You'll find redemption penalties stop you from moving during this period, and unlike a fixed rate, you can't control how high your rate will go. The MPC have been known to make up to six increases in the base rate within a year, and your interest rate will follow this.

You should also bear in mind that the heavier your discount is, the higher the jump in the level of your repayments will be when you discount period ends. How will you budget for this? What happens if you forget that your discounted period is about to end, and suddenly find yourself going into overdraft on your bank account because of the large amount of money that leaves your account that month.

You must also watch out for overhanging redemption penalty periods. This is the most basic way that the lender makes their money back from providing you with the discount on your mortgage. In general, you don't get anything for nothing, and you'll find that the higher the discount, the longer the overhanging redemption penalty period is likely to be.

Make sure you understand how discount mortgages are marketed. Whatever the discount is, will be the name of the product. So a "2% discount" is that amount off the lenders SVR. You must find out what the SVR is, because a 2% discount off one SVR could be a higher payable rate than a 1% discount off another.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

© AskFinancially.com 2009

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