A discounted variable mortgage (DVR) is a type of mortgage where the interest rate is set below the lender’s standard variable rate (SVR) for a specific period. Unlike fixed-rate mortgages, the interest rate on a discounted variable mortgage can fluctuate with changes in the lender’s SVR. Here’s a brief explanation of how it works:
- Interest Rate Calculation: The discounted variable mortgage tracks the lender’s SVR at a discounted rate. For example, if the lender’s SVR is 5% and the discount is 2%, the borrower’s interest rate would be 3%. If the lender later increases the SVR to 6%, the borrower’s interest rate would become 4%. It’s important to note that the lender can change its SVR at any time, making it challenging to plan your future budget.
- Comparison with Tracker Mortgages: While discounted variable mortgages and tracker mortgages are similar, there is a crucial distinction between them. Tracker mortgages typically follow an external rate, such as the Bank of England base rate, whereas discounted variable mortgages track the lender’s SVR. Tracker mortgages can change up to eight times per year if the Bank of England Monetary Policy Committee change the base rate, as they reflect changes in the base rate the following month, while discounted variable mortgages can change just as unpredictably as the lender’s SVR.
Pros of Discounted Variable Mortgages:
- Lower Interest Rates: With a discounted variable mortgage, borrowers enjoy an interest rate lower than the lender’s SVR for the discount period. This can result in lower monthly mortgage payments, providing immediate cost savings. Currently (correct as of 28/06/2023), many DVR mortgages are below both fixed rate and tracker rate levels.
- Potential Rate Decreases: If the lender lowers its SVR due to changes in the market or the Bank of England base rate, borrowers with discounted variable mortgages may benefit from even lower interest rates. This can lead to additional savings if interest rates are reduced over an extended period.
- Lower Early Repayment Charges: Discounted variable mortgages may have lower early repayment charges than fixed-rate mortgages. This may be advantageous if you plan to make extra payments or pay off the mortgage earlier, as it reduces the financial penalty associated with early repayment.
Cons of Discounted Variable Mortgages:
- Uncertain Monthly Payments: The main drawback of a discounted variable mortgage is the lack of fixed monthly payments. Even a slight change in the interest rate can impact your regular expenses. This can make budgeting more challenging, as the amount you pay towards your mortgage can change frequently.
- Collar Limitations: Many discounted variable mortgage deals include a “collar” clause that prevents the interest rate from dropping below a certain level. This limits your potential savings if the lender’s SVR decreases significantly.
- Additional Fees: While discounted variable mortgages may have lower fees than some fixed-rate mortgages, there are still associated costs, such as arrangement fees, early redemption fees, and exit fees. It’s essential to consider these fees when evaluating the overall attractiveness of the mortgage product.
If the monthly payments on your discounted variable mortgage become unaffordable, you have options. To switch to a different deal, you can explore remortgaging, but be aware of potential early repayment charges. Alternatively, you can discuss temporary solutions with your lender, such as switching to an interest-only arrangement or extending the term of your mortgage if they are part of the mortgage charter set out by the Rt Hon Jeremy Hunt MP, Chancellor of the Exchequer. However, these options may increase the long-term cost of your mortgage, so careful consideration is necessary. If you want to read the Mortgage Charter, you can click this link.
If you are due to remortgage in the next six months, then considering a discount variable rate mortgage could be a good option depending on your circumstances.
This blog does not constitute advice and is designed to explain a type of mortgage product.
Lewis Shaw (FCA registration number 927754), trading as Shaw Financial Services, is an appointed representative of King Mortgages Ltd, which is authorised & regulated by the Financial Conduct Authority, FCA registration number 803561.
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