The Basics: What are Fixed and Discount Rates? Fixed or Discount: The Easy Explanation Fixed or Discount: A More Advanced ExplanationLet me start by defining what we're talking about.
The Basics: What are Fixed and Discount Rates
Both discount and fixed rates are interest rates given as special introductory offers for mortgages. They usually last between 1 and 5 years. During that time it's likely you will be locked into that deal, with stinging penalties if you leave. It's definitely worthwhile double checking the product details before signing up for anything.
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The interest rate you pay is a fixed amount cheaper than the lender's Standard Variable Rate (SVR). The SVR is a rate set by each lender which moves up and down both with the
A discount rate works like this, then. A 1% discount off a Standard Variable rate of 5.75% means you pay 4.75%. If
Some discount rates are discounted off ‘Tracker Rates' not SVRs. This works in a very similar way, except a tracker rate simply means it tracks the Bank of England rate accurately. E.g. the tracker rate is always
So if you have a 1% discount off a tracker rate of base rate + 0.5%, then you will be paying base rate -0.5% (go on, go with the maths, it's not too difficult).
Advanced MoneySavers' note: SVRs
Unfortunately more often the SVR will not move exactly with the UK rates. So when interest rates rise by 0.25%, the SVR will probably go up by 0.3% - making a tiny little drop more profit for the lender. When the interest rate drops by 0.25%, the SVR may only drop by 0.2% - again making a tiny little drop more profit for the lender. Over time these little drops more profit form a huge lake.
With a fixed rate the rate doesn't change during the special offer period. It's, well… er….. fixed! So a fixed rate of 5% for two years means this is exactly what you will pay for two years irrelevant of any changes to
The advantage of a fixed rate is you know exactly what you'll pay during the entire special offer.
Advanced MoneySavers Note: How are fixed and discount rates set?
Discount rates are set on either the SVR or a tracker rate, both of which are primarily dependent on UK base rates. However, fixed rates are an entirely different beast. As a fixed rate lasts a long period, lenders base the rate they set fixed rates for at any one time on long term rates as defined by the City.
These can be moving in the opposite direction to base rates. So while the cost of discount rates can be increasing, fixed rates may be decreasing and vice-versa.
Fixed or Discount: The Easy Explanation
Usually fixed rates are set at a higher level than discount rates.
The major advantage of a fixed rate is ‘surety' – the knowledge of exactly what your mortgage repayments will be over the whole of the special offer period.
Deciding whether to fix is a question of weighing up how important that surety is for you. I tend to think of this as a ‘how close to the edge' are you?' question.
Someone who can only just afford their mortgage repayments should not be gambling with interest rates, and therefore will benefit much more from a fixed rate as it means they'll never be pushed over the brink by a rate increase.
Remember a discount is a little gamble
Even if in hindsight it may have been cheaper to take a discount, it doesn't mean going for a fixed rate was the wrong decision. It was the right one for you and for your peace of mind.
An Analogy: Heads or Tails
If I asked you to call head or tails on a coin toss and said I'll give you £10 if you win, but you only need pay me £1 if you lose, it's a worthwhile bet for you (and I'd be stupid and not worthy of my ‘Money Saving Expert' title).
- The bet itself doesn't increase your chances of winning, but it does mean the reward for winning is much better than the cost of losing. If we then tossed the coin and you lost, it was still a worthwhile bet.
- The same is true with taking a fixed rate. If you are doing it because with your personal circumstances ‘surety is important' the fact that with hindsight a discount would've been better doesn't make it the wrong decision.
Fixed or Discount: A More Advanced Explanation
OK. The above explanation works. However there is a slightly more sophisticated way to look at this. If the idea of a ‘sophisticated methodology' scares you, then quite simply stop reading now. There is no need to read on, it's just a little added extra.
First of all, remember the following assumes there is no other difference, except the rate and whether it's fixed or discounted. There should be no MIG, you must have the same deposit and the same fees, the special offer lasting the same amount of time, and the mortgage calculations must both be done on either a daily or annual basis.
If things aren't identical, then you must factor the impact of these differences into your calculation.
What's the difference?
· Two year discount with the current rate at 4.8%
However, it's also necessary to factor in the time frame.
The more comfortable your finances are the less you should be willing to pay for surety.
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