Buyers with a 5% deposit could possibly get a lower mortgage rate if you take out a price reduction mortgage, but are variable-rate deals worth it?
The cheapest introductory rate on a 95% discount mortgage is really a lot lower than that of an equivalent fixed-rate deal, even when factoring inside a possible increase in the Bank of England base rate, based on new information through which?.
Here, we explain how discount mortgages work and offer advice on the important thing things first-time buyers should consider when selecting a mortgage.
Discount mortgage leads the way for buyers with small deposits
Discount mortgages aren’t as popular as fixed-rate products, but first-time buyers could just be able to grab a good deal by heading down the discount route.
Loughborough Building Society is providing a market-leading 95% two-year discount mortgage with an initial rate of just 1.99%.
That’s 0.5% cheaper than its nearest competitor in the discount market (Teacher’s, at 2.49%), and 0.6% cheaper than the lowest-rate two-year fix (2.59%).
This price gap implies that even when Loughborough hiked its standard variable rate (SVR), the offer would be prone to remain cheaper than its competitors.
Loughborough discount mortgage: the details
How discount mortgages work
Discount mortgages are variable-rate deals that always come with short introductory relation to 2 or 3 years.
During this era, you’ll be charged the lender’s SVR, minus a set amount. Therefore if the SVR is 5% and the discount is 3%, your initial rate is going to be 2%.
Discount deals can be dangerous, as the margin (3% in this example) – rather than the rate itself – is fixed for the period. So, in case your lender increases its SVR to five.5%, which it could decide on at any time, you’ll need to pay a rate of two.5%.
It’s often the case that the headline rates on discount deals are slightly cheaper than fixed-rate products, but just a little rise in the SVR can quickly make sure they are more expensive.
SVRs and also the base rate
You may be surprised to understand that lenders’ SVRs vary dramatically – and will also get this amazing impact on just how much you’ll pay if you’re getting a discount mortgage.
Currently, Atom Bank has the cheapest SVR (4%) and Marsden Building Society the costliest (6.2%).
Right now, the typical SVR over the whole market is 4.89% – that’s the second-highest level observed in the past decade.
While SVRs can alter for several reasons (small business, the price of borrowing for banks etc), the single biggest thing that affects them is changes to the Bank of England base rate (currently set at 0.75%).
When the bottom rate increases (because it did in November 2022 and August 2022), lenders usually pass the burden on to borrowers.
You can easily see the effect of base rate rises and falls on SVRs in the chart below.
Are discount mortgages less expensive than fixes?
As the chart below shows, at every loan-to-value ratio (LTV) other than 95%, discount mortgages are only very slightly less expensive than their fixed-rate equivalents.
The biggest gap is at 60% LTV, where discount deals are 0.17% cheaper. At 90% LTV, the gap is just 0.04%.
With the possibility of SVRs changing anytime, the question of whether it’s worth taking a punt on these deals depends upon your appetite for risk and just what you believe can happen to rates of interest during these turbulent times.
What happens when the base rate rises?
In truth, nobody knows what’s going to take place to the economy, as uncertainty continues around Brexit.
The Bank of England governor Mark Carney has suggested a boost in the base rate could happen this year, so it’s worth considering how a 0.25% hike may affect the price of a discount mortgage, assuming your lender added the full increase to the SVR.
As the chart below shows, with the exception of 95% mortgages, the very best discount rates at each LTV would be expensive compared to cheapest fixed-rate deals.
The new Loughborough discount deal previously mentioned, however, would be cheaper than the present lowest-rate fix even if there have been two base rate rises of 0.25%.
You can find out how an interest rate rise would affect your monthly mortgage repayments using our mortgage rate of interest calculator.
At a glance: pros and cons of discount mortgages
| Advantages | Disadvantages |
| When the financial institution of England base rate (and for that reason your lender’s SVR) is low, your can benefit from a cheap rate. | Your lender’s SVR – and for that reason your repayments – can change at any time. If you’re with limited funds, this uncertainty could cause financial difficulties. |
| Some discount mortgages permit the flexibility to overpay and come without early repayment charges. | Discount deals often have a ‘collar’ which prevents the speed falling below a particular percentage in case your lender’s SVR plummets. |
| Introductory terms are generally 2 or 3 years, so you won’t be burdened having a variable-rate deal in the future. | If you take advantage of a very cheap discount deal, you will probably find it hard to replicate this low rate when you come to remortgage. |
Longer-term mortgage deals
We’ve only analysed two-year discount and fixed-rate mortgages here, but what about longer-term deals?
Over recent times, the space in cost between two- and five-year fixed-rate deals has closed significantly, as an increasing number of homebuyers and remortgagers have chosen the security of a longer-term fix.
If you’re seeking to secure your rate for five years, you’re unlikely to find several choices in the discount market.
A select few of lenders – Bath, Beverley, Buckinghamshire, Loughborough, Mansfield, Melton Mowbray, Newbury, Scottish Building Society, Tipton and Coseley and Vernon – offer three-year discount deals at 95% LTV, though some of these deals are only open to people in specific professions, or require financial assistance from a family member.
In the five-year market, meanwhile, only three lenders – Earl Shilton, Hanley Economic and Loughborough – offer discount mortgages.
With this in mind, borrowers in search of longer-term rate security would get a much more choice by opting for a fixed-rate deal.
