These are called ‘honeymoon’ loans because of the honeymoon period during which you pay a discounted interest rate – often the cheapest on offer – for an initial period of time. The discounted period is usually 12 months, though some lenders offer the discount for as little as six months or for up to three or four years.
The introductory rate can take one of two forms, the first being a ‘fixed discount’ and the second being a ‘discounted fixed’ rate. The fixed discount is a rate that will be variable, but fixed at a certain level or margin below the standard variable rate. This means that for the introductory period, the discounted rate will move with the market. If the standard variable rate rises by, say, 0.50%, so will the discounted rate, and if the standard variable rate drops by 0.50% the discounted rate will also drop. The discounted fixed rate, on the other hand, is a rate fixed for the introductory period of the loan, and won’t move with the market.
While these loans are popular, there are a number of things to consider. Most of these loans will ‘roll over’ (revert) to the standard variable rate after the initial introductory period. This means that any benefit you may have had by way of a cheap rate for the introductory period may be negated by the fact that you might now be paying what is generally the most expensive rate in the lender’s variable suite. Some lenders may also ‘cap’ or limit the amount of extra money you can pay off the loan during the introductory period.
You should also check what sort of exit fees you have to pay after any period of the loan. For example, you will generally have to pay an exit fee of some description if you pay out the loan or refinance during the introductory period. This basically encourages borrowers not to jump from honeymoon product to honeymoon product, and allows a lender to cover costs incurred during the introductory period.
If you take out an introductory rate loan you may want to consider making repayments at the roll over rate (if the loan product allows it) rather than at the introductory rate.
Borrowers get a ‘softer’ introduction to having a mortgage because they are paying lower instalments during the introductory period. This can help you get ahead financially during the first months.
When the honeymoon period ends, the interest rate is likely to be higher. It is important to find out what the revert rate is to make sure you don’t cancel out your savings. The cost of discharging the loan or switching during the introductory period can also be quite high.
First homebuyers who are breaking into the mortgage market would benefit from the lower introductory rate while they get used to paying their loan.