Daily Interest Calculation

Pjm77

Just reviewing my latest mortgage statement and I think the interest calculation is incorrect.

Before I challenge I'd like to clarify that the correct way to calculate the daily rate is as follows;

Annual rate ^ (1/365)

In my case 2.59% annual rate this gives;

1.0259^(1/365)=1.000070058 (0.0070058%)

However on my statement the bank have ignored daily compounding and have just calculated it as;

2.59/365=0.0070959%

But to me this is wrong as 1.0070959^365=1.0262 (2.62%), so appear to be charging 0.03% more than the correct annual rate.

The differences look small but my daily interest on £160k balance should be £11.21 but using their method it's £11.35. That 14p a day is £51.10 a year so very significant over a 25 year mortgage term.

My Mortgage is with First Direct but checked an old HSBC statement and they appear to also calculate it this way.

Are they allowed to calculate daily interest this way if so this must make them a fortune given their Billions on mortgage loans?

Imma_Number

Annual rate ^ (1/365) assumes they are compounding the interest daily but that isn't the case. i.e. they aren't charging you interest on the interest they charged you yesterday. At least not if you keep paying.

The interest is calculated daily, but compounded monthly.

TrickyDicky101

Imma_Number wrote: »

Annual rate ^ (1/365) assumes they are compounding the interest daily but that isn't the case. i.e. they aren't charging you interest on the interest they charged you yesterday. At least not if you keep paying.

The interest is calculated daily, but compounded monthly.

Unless using an effective rate compounding frequency is irrelevant to the daily interest calculation. Most likely, OP has an annualised nominal SVR or Fixed Rate in which case the calculation would be 1/365 * Rate

Pjm77

Thanks for replies, think I now understand that as interested is only added monthly and the covered by my payment it never gets compounded so rate/365 makes sense.

Confusion arose as also looked at a deferred student loan account where the daily interest is calculated allowing for compounding, but here that is correct as no payments are made so interest is compounded.

Issue with compounding would arise on a mortgage if you stopped paying the monthly repayment, then monthly interest compounding would kick in increasing the annual rate above the actual rate. However in this scenario you'd be in arrears so a slight difference in the interest calculation would probably be the least of your worries!

Although if you'd been overpaying and got the lender to agree a payment holiday would they then adjust the interest calculation to allow for the monthly compounding?

TrickyDicky101

There is no adjustment - rates don't change whether you pay your monthly payment or not. You are charged interest on whatever basis you agreed to when the mortgage was taken.

Thrugelmir

Pjm77 wrote: »

Thanks for replies, think I now understand that as interested is only added monthly and the covered by my payment it never gets compounded so rate/365 makes sense.

Differing number of days in a month makes a difference as well. While your payment remains static as is set to pay the mortgage off over the entire term.