What is a Discounted Variable Mortgage?

07/05/2019
Discounted variable mortgages - or discount mortgages - are a particular type of variable rate mortgage, i.e. where the interest charged can vary month by month and is calculated as a set discount from the lender's standard variable rate (SVR).

They clearly differ from fixed rate mortgages, where the interest rate is fixed but they also differ from tracker mortgages, because although the latter are also variable, these track an underlying index, which in a large majority of cases is the Bank of England base rate.

They are often reported as being the cheapest mortgages in terms of initial set up fees and rates offered, however, if you are considering mortgages, you need to understand how they work and how they compare to other types in different circumstances in order to make the right choice.

The variable nature of the required interest payments should give you a clue that under unfavourable circumstances, you might end up paying more money than you'd wish on repayments. We cover these matters below and summarise them in our list of Pros and Cons.

This article therefore considers discount variable mortgages and examines:



Are you considering a discount mortgage for buying a home?

These are often the cheapest mortgage products to set up but you should understand their Pros and Cons fully particularly in view of their varying rate nature. Our independent mortgage brokers can help you find the right product for your needs from 1000s of mortgage products.

* Access to whole of the market – Available Outside of Work Hours – No need for face-to-face meeting with mortgage advisor - Terms Apply


    1

    How long do discounted variable mortgages last for?

Discount mortgages can run for any length of mortgage term, from 2 years to 25 years (or longer, depending on the lender).

In this way they behave much like fixed rate mortgages (although the fixed period of these tends to be for 10-year periods or less). What is important, however, is to note exactly when the discount period starts - and therefore when it ends - because, as with fixed rate mortgages, after this you'll be put on the lender's SVR, which always means much more expensive monthly payments.

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    2

    What affects the lender's SVR which the discount tracks?

While your lender will normally respond to a change in the Bank of England's base rate by varying its SVR to mimic the change, it can alter its rate for any number of other reasons which have nothing to do with this and are not predictable externally. Although it might seek to avoid changes which mean mortgagors are charged too much - thus encouraging people to change provider or product - you must understand that the SVR can change without warning.

    3

    What happens if you want to change mortgage?

You can change from a discount mortgage to another type without penalty once the term of the discount has finished. The challenge, however, is when you want to change out before the term is finished.

Although there are mortgages where you don't have to pay an early repayment charge (ERC) (also known as an early redemption charge), these tend to be ones with much higher interest rates and/or are only offered when you are borrowing a maximum 80% loan-to-value (LTV) or below. If you are getting a standard 90% mortgage or higher, it's uncommon for lenders not to charge an ERC and these can be very expensive.

The way the ERC is calculated varies greatly from mortgage type to mortgage type. With discount mortgages, the ERC may be based on a fixed amount of interest. For example, you might pay 2 or 3 months’ interest if you come out of a discounted or tracker rate early. Fixed rate mortgages charge a percentage on the whole sum - anything from 2% to 6% (6% might be levied on a 10-year fix).

You should ensure you understand the ERC terms of any mortgage you opt for and discount mortgages are no exception. That said, you might find that an ERC for a discount mortgage might be favourable compared to a fixed mortgage of the same term. This is worth bearing in mind if you think there's a chance that you'll want to sell up before the end of the term, particularly if you end up borrowing less on the next purchase you make or there's a gap between your sale and the next purchase: in these situations you're likely to have to pay an early redemption charge.

    4

    Pros and Cons of discount mortgages


Pros

  • When the lender's SVR rate is low, your payments will be lower.
  • Frequently lower arrangement fees than for fixed rate or tracker mortgages.
  • A capped deal - if you can find one - means you'll never pay above a certain fixed interest rate (i.e. the cap).
  • Early repayment charges might be lower than for comparable fixed rate mortgages.

Cons

  • Lender can increase its SVR for its own reasons, not just in line with a base rate rise.
  • If the SVR rate goes up, your payments go up. Bear in mind that for a £150,000 mortgage, a 1% increase might add an extra £166 per month to your repayments.
  • There is often a collar, which means that your repayments can only drop to a certain fixed level regardless of the SVR (works almost in the opposite way to caps, see above).
  • If you've a large discount, you might be particularly vulnerable to a sudden jump in repayment level when your term ends and you're put onto the lender's SVR.

    5

    How do you get a discount mortgage?

You can approach any lender or mortgage broker however we recommend that you consult an independent mortgage broker because they are not tied to any particular lender's products: they have access to the whole of the market of tens of 1000s of mortgage products. They can help you select the right mortgage for your own specific needs.


Are you considering a discount mortgage for buying a home?

These are often the cheapest mortgage products to set up but you should understand their Pros and Cons fully particularly in view of their varying rate nature. Our independent mortgage brokers can help you find the right product for your needs from 1000s of mortgage products.

* Access to whole of the market – Available Outside of Work Hours – No need for face-to-face meeting with mortgage advisor - Terms Apply


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