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Should first-time buyers avoid fixed-rate mortgages?

Discount mortgages could offer a cheaper option to some buyers

The majority of first-time buyers choose a fixed-rate mortgage, lured by the promise of unchanging monthly payments. But in a market offering historically cheap deals, are there better alternatives available?

While fixed-term mortgages have largely cornered the first-time buyer market, new data shows discount mortgages may offer a better deal – but only in certain circumstances.

Here, we take a look at how discount mortgages work and investigate whether the numbers stack up against popular fixed-rate deals.

 


What is a discount mortgage?

While fixed-rate mortgages lock in your interest rate for a set number of years, rates on discount mortgages are variable from day one.

With this type of deal, your interest rate is based on a discount of your lender’s standard variable rate (SVR). Like fixed-rate offers, discount mortgages are usually offered for a set number of years, after which you’ll move to the SVR.

Let’s take a simple example. If your lender’s SVR is 5% and your deal offers a discount of 1%, you’ll pay 4% interest. This means payments can be volatile if rates change –  if the lender’s SVR rises to 6%, you’ll pay 5% interest.

  • Check out our full guide for more on how discount mortgages work, including how the Bank of England base rate affects what you’ll pay.

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Are discount deals cheaper than fixed-rate ones?

You might have heard that interest rates on fixed-rate mortgages are at historic lows – and that’s partly true.

If you have a 10% deposit, you can access some great initial rates. But it’s a different story for first-time buyers with a 5% deposit.

According to data from Moneyfacts, initial rates on fixed-rate 95% mortgages are actually going up rather than down. At the same time, discount mortgages at the same level of borrowing are getting slightly cheaper.

The chart below shows that the average rate on a two-year discount mortgage at 95% loan-to-value was 0.82% cheaper than an equivalent fixed-rate deal in August – almost double the difference recorded six months earlier.

This means that while rates on discount mortgages have only dropped slightly compared to a year ago, they are becoming increasingly good value for buyers with 5% deposits.

Should I choose a discount deal?

Right now, the Bank of England base rate is at a record low of 0.25%, bringing down lenders’ standard variable rates. As a result, discount mortgages are currently offering big overall savings for first-time buyers with small deposits.

Indeed, research from Moneyfacts in August showed that borrowing £200,000 over 25 years using an 95% two-year discounted mortgage would leave you £1,071 a year better off than an equivalent fixed-rate deal.

Ultimately, whether you should choose a discounted mortgage will depend on your appetite for risk.

As it stands, even if the Bank of England base rate increased to 0.5% during the term of your discounted deal, you could still be better off.

For ultimate protection against interest rates soaring, however, a fixed-rate mortgage remains the safest option.

Saving more unlocks fixed-rate bargains

Fixed-rate mortgages aren’t necessarily a bad idea for first-time buyers – but simply put, they’re a much better idea if you can table a 10% deposit.

Earlier this week, the number of fixed-rate mortgages on offer at 90% loan-to-value hit 275 – an all-time high, and a 29% increase in the space of just a year.

This level of competition means that while rates aren’t dropping at the same speed they were a couple of years ago, they’re still highly competitive.

Mortgages at 90% loan-to-value Sep 2015 Sep 2016 Sep 2017
Number of two-year fixed mortgages 197 196 275
Average interest rate 3.35% 2.86% 2.63%

Data from Moneyfacts

That said, initial interest rates are only one way of comparing mortgages. Before making a decision, it’s important to look at the overall costs to you over the life of the deal, including any fees or charges. You’ll also need to take into account your long-term plans and financial circumstances.

Your home may be repossessed if you do not keep up repayments on your mortgage.

Which? Limited is an Introducer Appointed Representative of Which? Financial Services Limited, which is authorised and regulated by the Financial Conduct Authority (FRN 527029). Which? Mortgage Advisers and Which? Money Compare are trading names of Which? Financial Services Limited.

Categories: Money, Mortgages & property

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