Discounted Mortgages

One of the simplest of schemes to understand. The lender offers a discount off their standard variable rate (SVR) for a given period of time. Typically, this will be for 2, 3, or 5 years with the greatest discounts offered for the 2 year deals. So for example, if the lender's standard variable rate is 6.7%, a two year 2% discount, will result in a pay rate of 4.75% for two years. After the discount period is passed, the rate will revert to the lenders SVR at that time.

Advantages of discount mortgages

Discount mortgages probably offer the lowest initial mortgage payments compared to the other types of mortgages available. If mortgage rates fall - provided that the lender reduces their standard variable rate, payments will fall too.

Disadvantages of discount mortgages 

The obvious disadvantage of discount mortgages is that if interest rates, and mortgage rates rise, so do your monthly mortgage payments. Unless there is a cap on the rate payable, which would be unusual, the rate, and therefore payments can rise without limit.

You will usually have to pay redemption penalties to switch out of your discounted mortgage. This can leave you in an uncomfortable position when interest rates are rising quickly.

Beware this trap 

Not so common now, but very common during the 1990's was the practice of extended redemption penalties. Usually applied to discounted mortgages, but also to every other type of deal.

Lenders vie to be "top of the tables" for cheapest rates. As a lender, if you can undercut the cheapest discounted rates offered by your market competitors, then you are likely to secure more business. However, your profit margins may be cut to unnacceptably slim levels. One method of offering cheap rates, whilst at the same time maintaining profitability, is the use of extended redemption penalties.