Cut your current mortgage interest rate to just 1.99%!

Want to reduce your current mortgage interest rate? This super cheap new mortgage will definitely catch your eye, but watch out for the sting in the tail.

I’ve lost count of the many, many times we’ve argued the ‘fixed versus tracker’ mortgage debate at lovemoney.com. It’s a financial question which never has a clear cut answer, which is why we revisit the topic time and time again.

But today I want to look at something a bit different: discount mortgages. Discount deals never seem to get the same exposure that fixed rates and trackers enjoy. I think it’s about time that changed.

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What is a discount mortgage?

Discount mortgages are nice and easy to understand (makes a change!) Quite simply, the rate on offer will be set at a specific margin below the lender’s standard variable rate (SVR) - or Existing Borrowers Rate - for a set period.

For example, if a lender’s Existing Borrowers Rate is 4.99% and the discount is 1.5%, you’ll enjoy a pay rate of 3.49%. Discounted rates are always variable, and will move up and down in line with changes to the standard rate.

Of course, the discount often makes the pay rate look very cheap too. Take the top ten deals, for example. Every one of them offers a variable rate of less than 3%. This makes them worthy of a closer look:

Top 10 discount mortgage deals (by rate)

Source: Moneyfacts. *Lending area: East Anglia. **Lending area: Bath, Bournemouth, Brighton, Bristol, Dorchester, Hemel Hempstead, Gloucester, Guildford, Oxford, Portsmouth, Redhill, Salisbury, Slough, Southampton, Swindon.

The number one deal from HSBC is a two-year discount mortgage launched earlier this month. It has already caused a bit of a stir, particularly with borrowers who are lucky enough to have large amounts of equity.

As long as you can meet the loan-to-value requirements - you’ll need a minimum deposit or equity of 40% - you’ll enjoy a current super low discount rate of just 1.99%. This is one of the most competitive rates across the entire mortgage market.

What’s more, the deal seems reasonable in other respects. The product fee, for example, is fairly standard at £999 and the early repayment charge - 1% of the sum repaid - doesn’t extend beyond the two-year introductory period.

The other discount deals shown are also pretty attractive with rates that easily beat the majority of fixed rate and tracker mortgages.

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Are discounts better than trackers?

But do discounts really offer anything more than the best buy trackers? 

It’s true there aren’t many tracker deals which can boast rates as cheap as HSBC’s new discount. Alliance & Leicester has had a go with trackers rates of 1.84% (BBR + 1.34%) and 1.89% (BBR + 1.39%). But these deals come with mighty product fees of 2% of the mortgage, which destroys what looks like a seemingly competitive choice.

That said, there’s a whole lot more to a decent mortgage deal than a cheap headline rate.

One factor you should always bear in mind with discounts is that the lender can alter their SVR, or Existing Borrower Rate, whenever they choose. Once upon a time, SVRs tended only to move following a change in the base rate. But since the whole mortgage system has been thrown into chaos, with the base rate as its lowest ever level, that trend doesn’t necessarily apply anymore.

Most trackers, on the other hand, are directly linked to the base rate, so you know your pay rate will only ever change if the base rate moves first. But with discount deals, there’s a chance your rate could increase even when the base rate is constant.

In this way, discount deals have even less certainty than trackers. You could argue trackers mortgages are pretty much guaranteed to become more costly since the base rate can only move upwards next.

But I would say this is relevant to discount deals too. After all, while an increase in the base rate won’t automatically mean your discount rate rises, lenders are bound to use it as an opportunity to step up their SVRs and Existing Borrower Rates. This will mean higher rates for borrowers on discount deals.

Should I avoid discount deals then?

If you choose any variable mortgage – whether you go for a discount or a tracker – it’s sensible to choose a deal without an early repayment charge (ERC). That way, if the rate rises beyond your budget, you can remortgage without it costing you an arm and a leg.

With an ERC of 1% of the sum repaid - which on remortgaging would mean 1% of the amount still owed to the lender - borrowers could get stung if HSBC increases its Variable Rate significantly during the two-year period when the ERC applies.

This is the risk you'll have take with the majority of discount deals. Only you can decide if you’re comfortable taking this kind of gamble on mortgage rates. If you don’t want to take your chances, but you still want a discount deal, you could avoid the problem by choosing a mortgage without ERCs, such as the Leek United or Market Harborough deals.

If you need more help with your mortgage dilemma, pose a question on our excellent Q&A tool and find out what the lovemoney.com community would do in your shoes.

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