By Ashley Pearson, Head of Intermediaries at The Loughborough Building Society
Discount mortgages are a frequently misunderstood area of the mortgage market, but for the right borrower, they can be a useful financial tool offering greater flexibility over their monthly mortgage payments and future needs.
While it’s true that many borrowers tend to prefer the certainty of a fixed rate product, especially in a period of economic instability, there are circumstances where a discounted mortgage product may prove more attractive and better suited to clients’ needs.
A common misconception around discount mortgages is that the interest rate can fluctuate wildly on a regular basis, leaving borrowers with the risk of being unable to cover the cost of the mortgage.
While, of course, it’s important to stress test affordability at the highest possible level to ensure borrowers can continue to repay the mortgage, it’s also important to note that the discounts on offer are directly related to a lender’s SVR and not the Bank of England base rate.
This means that any decision to increase or decrease the SVR is made by the lender. It also means that if the Bank of England increases or decreases the base rate, it doesn’t mean the lender will follow suit.
Discounted mortgages can offer greater levels of flexibility for those borrowers who may find themselves in a position to regularly overpay. This can be an ideal solution for borrowers with more cash at their disposal or those who can afford to absorb any fluctuations in payments that may occur over the mortgage term.
Unlike fixed rate products, it can be the case that there are no limits or penalties for overpaying, which can help those borrowers with potentially more irregular income streams who may be looking to clear their mortgage faster. This can be particularly useful for borrowers who know they are coming into a large amount of money during the mortgage term, perhaps due to selling other assets or coming into some inheritance.
Although paying off a mortgage before the end of the deal often comes with an early repayment charge (ERC), these ERCs can be much less onerous with a discount mortgage, ensuring that borrowers can make further savings should they need to exit the loan early.
For example, here at the Loughborough, the ERC on our discount product range is currently set at 0.5% in the first year and 0.25% in the second year. The equivalent of only £1,000 on a £200,000 loan in the first year of the mortgage and £500 in the second year, depending on the total balance and term left at the time of redemption.
This can be an attractive proposition for those borrowers who may require an option to leave the mortgage before the end of the current term or those who may benefit financially from moving early to another mortgage product due to expected or unexpected positive market movement.
Admittedly, a discount mortgage may not appeal to every borrower, and while there will always be situations where a discounted mortgage will not represent the best fit for the client, there will also be cases where the flexibility of a discount mortgage can be of great benefit. Key factors to underline how discounts are playing an increasingly prominent role in the advice process for many borrowers.