A discount mortgage is a type of mortgage where the interest rate is set at a certain percentage below the lender’s standard variable rate (SVR) for a specified period.
What is discount mortgage?
The discount is usually expressed as a percentage, and the discount rate determines the actual interest rate charged on the mortgage for the period. For example, if the SVR is 5% and the discount is 1%, the borrower would pay an interest rate of 4%.
The discount period is a fixed timeframe during which the borrower enjoys the discounted interest rate. This period can vary, typically lasting for a few years, such as two, three, or five years.
Once the discount period expires, the mortgage interest rate typically goes back to the lender’s SVR. At this point, the borrower will pay the standard variable rate unless they choose to switch to a different mortgage deal. Since the interest rate is linked to the lender’s SVR, it can vary. If the SVR increases, the borrower’s mortgage payments may rise after the discount period ends.
Some discount mortgages may offer flexibility, allowing borrowers to make overpayments or pay off the mortgage early without incurring significant penalties.
Example of discount mortgage
Let’s say a lender has a standard variable rate (SVR) of 5%, and they offer a discount mortgage with a 1% discount for the first two years. In this case, the borrower would pay an interest rate of 4% during the initial discount period.
For instance, if a borrower has a loan amount of £20,000, the interest payable for the first two years would be calculated as follows:
Year 1: Loan amount x Discounted interest rate = £200,000 x 4% = £8,000
Year 2: Loan amount x Discounted interest rate = £200,000 x 4% = £8,000
After the initial two-year period, the mortgage would typically revert to the lender’s standard variable rate