As if all the different types of mortgage products for contractors weren’t confusing enough, people who decide to opt for a contractor variable rate mortgage then have a number of further choices to make as to what type of variable rate they want. As we have seen elsewhere on the site, variable rate mortgages are products wherein the rate of interest can go up or down at any time during the lifetime of the loan. Once the Bank of England base rate goes up you can be assured that your lender will follow, often adding a bit themselves too. On the other hand, if interest rates drop, being in a variable rate mortgage is much more beneficial than being tied into a higher, fixed rate.

Choosing which sort of variable rate mortgage is the right one for you can be a bit of a minefield though. As well as standard variable rate mortgages there are tracker rate mortgages, capped rate mortgages and discounted rate mortgages. All of these are discussed elsewhere on this site, whilst here in this article we will be looking at discounted rate mortgages.

What are discounted rate mortgages

A good way of thinking about them is to consider them like a standard variable rate mortgage but with a special offer that is designed to draw you in. They operate at a level that is cheaper than your lender’s standard variable rate whilst also being linked to it. As an example, suppose your lender has their standard variable rate set at 5% but the discounted being offered is 2% then your mortgage rate would be 3%. That discounted rate will normally be offered for a set introductory period, which can be anything between 2 and 5 years. As soon as that introductory offer ends you will be switched back to the standard variable rate.

The advantages of a discount rate mortgage.

Firstly, the main advantage of discount rate mortgages is that they are much cheaper when you start out. For people on a tight budget and trying to get on the housing ladder this can be a godsend and those first few years of lower mortgage repayments the difference between getting a house or not. Moreover, should your lender decide to cut their standard variable rate then people on discounted rate mortgages will see their repayments drop even further. Thirdly, if the base rate set by the Bank of England goes down you should also see a drop (though this is never guaranteed). Finally, they offer all the same advantages of standard variable rate mortgages – not being fixed in to higher rates, flexibility etc

The disadvantages

Firstly, some lenders who offer discounted rate mortgages will take away some of the benefits associated with standard variable rate mortgages, such as being a cheap option to set up and costing nothing to make early repayments. Instead, many will charge you early repayment charges if you decide to leave before the end of the tie in period and many will even charge you for two or three years after the discounted period. Secondly the advantages of the variable rate also become disadvantages sometimes; if the lender changes their standard variable rate for the worse then your discounted rate will follow suit and you might suddenly find yourself with increased (and unaffordable) mortgage repayments. The same applies if the Bank of England increases their base rate.

To summarise, discounted rate mortgages are best suited to those people who want to pay much less for the first few years of their mortgage but who are aware that rates can rise in the future. One way of preparing is to look at the standard rate when making plans and then consider the discounted rate as a ‘bonus.’