Compound Interest on Interest Only Mortgage??

DaemonicTrolley

Maybe I'm going mad but I think my bank is being very sneaky...
I have an interest only mortgage paid by direct debit each month and the balance is rising.
After several long phone calls it seems there are a couple of things going on which shocked me - so perhaps someone can tell me if this is normal behaviour from the banks???

Firstly, the initial payment taken was more than a month after the mortgage was taken out, and it didn't cover all the interest that had accrued (so immediately my balance had gone up). This happened because they let me choose the payment date but didn't explain that it might affect the amount of interest paid.

Secondly, they tell me that every time the interest rate drops, my direct debit for the month will underpay the interest again (I'm on a variable rate currently).

Finally they confirmed that I would be paying compound interest on the unpaid interest accrued.

Apparently they calculate the interest daily using the interest rate associated with my particular mortgage and add it to the account monthly. When they come to compute my DD payment, they use whatever interest rate is associated with the mortgage at the time the payment is computed (so if the rate changed through the month the payment is wrong).

I'm gobsmacked. Surely the DD should simply be the amount of interest accrued since the last payment was made.

Am I being naive? Is this just how it works? Of course I didn't read the Ts & Cs all that closely, I assumed how the DD would work..

What do you MSE folks think about this? Any suggestions gratefully received.

Trying_to_be_good

Regarding the first month's payment, I'd just overpay the difference and that should be a one off.

The easiest way to deal with the other issue is to pay the mortgage on the first of the month, or whatever day of the month interest is applied if that's different.

Do you have a plan for how to pay off the capital you owe? You couldn't go far wrong with overpaying now, if you can afford it and there aren't penalties.

DaemonicTrolley

Thanks for the quick reply.
I can certainly address the specific issues, and I guess change my payment date to match their interest rate change date - but it seems sneaky what they do and I wonder how many people don't notice it happening...

Your suggestion of overpaying is an interesting one and I'm not sure what the right answer is. We are actually renting out the property this mortgage is on, and expecting to right off the interest payments against the rental income before paying tax (which we pay at the higher rate). So, I think I probably don't want to overpay but haven't done the sums in detail to be sure!

Robert_Sterling_3

The daily rate does compound the interest everyday but the daily rate after compounding every day for a year is then equal to the annual rate.

Mathematically the daily multiplier ( which is 1 + the daily rate of interest ) is the 365th root of the annual multiplier ( 1+ the annual rate of interest ).

i

ILW

Robert_Sterling wrote: »

Mathematically the daily multiplier ( which is 1 + the daily rate of interest ) is the 365th root of the annual multiplier ( 1+ the annual rate of interest ).

i

I knew that!!!!!!

Robert_Sterling_3

believe it or not there are some who do not.

DaemonicTrolley

My concern is not so much that the daily interest compounds each day but that while compounding, it should be cleared down to the starting balance whenever I make a payment. If that doesn't happen then, because it's an interest only mortgage, my "initial balance" (is principal sum the right term here?) has been permanently increase by the amount of interest missed...

Robert_Sterling_3

I understand what you are saying now.
You are on intererest only and your balance keeps increasing.
This is called a ballooning account.
I would be interested to know:-
Initial balance and Current balance.
I think there should be some onus on tour lender to do what you would expect and by direct debit keep your outstanding balance constant and equal to the original amount.
Power to your elbow.