Discounted variable mortgages explained – should I get one?

If you’ve been offered a discounted variable rate mortgage, you’re probably wondering how it compares to other types of mortgages and mortgage deals.

Broadly speaking, in terms of attractiveness these fall somewhere between tracker mortgages and SVR mortgages.

The interest rate can change and make your mortgage more expensive, but usually not as expensive as with an SVR mortgage.

What is a discounted variable mortgage?

All mortgage lenders have a standard variable rate (SVR), which is an interest rate set at their discretion. The SVR is influenced by the Bank of England base rate, but not tied to it. If you are on a fixed or tracker mortgage and your deal period comes to an end, you will revert to an SVR mortgage unless you remortgage.

A discount variable mortgage sets the interest rate you pay at an amount below the lender’s SVR for a defined period. Your interest rate is not fixed and will increase or decrease in relation to changes to the lender’s SVR.

How does a discounted variable mortgage work?

A discounted variable rate mortgage works a bit like a tracker, except instead of tracking an external base rate, it tracks the SVR at a discounted rate.

For example, if your lender has an SVR of 4 per cent and your discount is 1 per cent, your interest rate will be 3 per cent. If the lender then raises its SVR to 5 per cent, your interest rate will be 4 per cent. It is worth remembering that your lender is free to change its SVR at any time, which can make it tricky to manage your future budget.  

Discount vs tracker mortgages

As mentioned above, discounted variable mortgages function in a similar way to tracker mortgages. However, there is one key difference. Tracker mortgages commonly track the Bank of England base rate of interest, with a margin added by the lender. This means they often have among the lowest interest rates available.

Discount variable mortgages, by contrast, track the lender’s SVR. This means that although they are cheaper than SVR mortgages, they can change just as unpredictably. Tracker mortgages, by contrast, won’t change nearly so often.

What are the advantages of a discounted variable mortgage?

Depending on the alternatives you are offered, there may be a number of potential advantages to a discount variable mortgage:

• You will pay a lower interest rate than your lender’s SVR for as long as your deal lasts
• It’s possible you’ll pay an even lower interest rate if your lender reacts to a change in the Bank of England base rate by lowering its SVR (however, the base rate has been at historically low levels for over a decade)
• You will likely have lower early repayment charges compared to fixed-rate deals, which could help you pay less in fees if you decide to overpay each month to pay off the loan quicker

What are the disadvantages of a discounted variable mortgage?

The main disadvantage of a discount variable mortgage is that your monthly payments are not fixed. Even a 0.5 per cent change to your rate could add a significant amount to your regular outgoings. If you can manage your financial situation around this, an increase may not concern you too much. However, it can be harder to budget effectively if the amount you pay for your mortgage changes fairly regularly.

You’ll also find that many discount variable mortgage deals will have a ‘collar’ that stops your interest rate from dropping below a certain level, therefore limiting the savings you can make.

What fees relate to a discount mortgage?

There will be some additional fees to pay when you arrange your mortgage, though usually not as much as with some fixed rate deals. You need to make sure any fees you pay don’t affect the overall attractiveness of the deal before you sign up. Your broker will be able to tell you if you will also be charged arrangement, early redemption and exit fees.

How do I get a good discounted variable mortgage deal?

Your mortgage broker will survey the market for you to find the best discount mortgage deals. Their experience will be useful as you try to balance the potential benefits and risks of different kinds of mortgages.

It’s important to make sure you get a mortgage deal that works for you over the long term, and your broker may advise that the lack of certainty offered by a discount variable mortgage is not right for you at this time. It may be more suitable when you come to remortgage (you can learn everything you need to about the process with our guide to remortgaging).

What can I do if my discount mortgage repayments become unaffordable?

With the potential for sudden shifts in your interest rate, you may find it difficult to make your monthly payments. If this happens, you have a number of options. You could try to remortgage and move onto a different deal, although you may have to pay an early repayment charge, so check to see if this makes it worthwhile.

By talking to your lender, you may also be able to agree a temporary solution such as switching to an interest-only deal or taking a break from your repayments. These actions will add to the cost of your mortgage in the long-run but might help you manage your financial situation better in the short term.

Ask a mortgage broker to help you choose the right deal for you. Even allowing for mortgage broker fees they can save you much more money in the long run.