Is my mortgage company overcharging me interest?

ntadmin

According to my (ex) mortgage company, interest on mortgages is calculated daily and capitalised annually. This means that each day the daily interest for the debt is calculated and added to the "interest for the year so far" pot which is added to the mortgage at the end of the year.

When checking the figures, I discovered that what they actually did was to take my monthly payment, remove the interest calculated in the previous month, and then take the remainder off the outstanding debt.

It seems to me that this is (mathematically) the same as adding the interest to the debt on the payment date and then taking the payment off the total, ie what they would call "monthly capitalisation of interest".

Now, the daily interest rate is the annual interest rate divided by the number of days in the year - exactly correct for if the interest is only added to the debt at the end of the year. But they didn't, they added it in every month.

I suspect (and I've done quite a few numbers that makes me think I'm correct), that they are therefore gaining extra money out of me each year.

I have asked them a number of times and they have agreed that my description above of how they act is correct but claim that this procedure of subtracting the monthly accrued interest from the payment is a valid for of "annual capitalisation". I disagree.

Who is right? Have I been overcharged? Anyone else noticed this?

Thrugelmir

ntadmin wrote: »

I have asked them a number of times and they have agreed that my description above of how they act is correct but claim that this procedure of subtracting the monthly accrued interest from the payment is a valid for of "annual capitalisation". I disagree.

I agree with your lender.

Now, the daily interest rate is the annual interest rate divided by the number of days in the year - exactly correct for if the interest is only added to the debt at the end of the year. But they didn't, they added it in every month.

Your interest wasn't recalculated though every month. Adding the interest and deducting the payment shows the balance you actually owe at the end of every month. Doesn't impact the way the calculation works.

getmore4less

I agree with the op what the mortgage company described is not what they do.

They are capitalising(compounding) the interest monthly

Thrugelmir

getmore4less wrote: »

I agree with the op what the mortgage company described is not what they do.

They are capitalising(compounding) the interest monthly

That would be to the OP's benefit. As the interest would then be calculated on a lower balance that's owed.

ntadmin

Interesting. Here's a simplified numbers example:

Debt: £1000
Interest: 10% per year.
Monthly payment: £40

To make the numbers nice: assume 5 months a year with 40 days each month

So the daily interest rate(annual capitalisation): 10%/(5 x 40) = 0.05%

Standard method:
Month 1 interest 40 days x £1000 x 0.05% = £20.00
Month 2 interest 40 days x (£1000 - £40 = £960) x 0.05% = £19.20
Month 3 interest 40 days x (£980 - £40 = £920) x 0.05% = £18.40
Month 4 interest 40 days x £880 x 0.05% = £17.60
Month 5 interest 40 days x £840 x 0.05% = £16.80
End of month 5: £840 - £40 = £800

Total interest accrued : £92
Capitalise that, so end of year debt = £800 + £92 = £892

So you have paid £200 and reduced the debt by £108.

Their method
(to simplify, I've rounded in their favour)
Month 1: 40 days x £1000 x 0.05% = £20.00
Month 2: 40 days x (£1000 - £40 + £20 = £980) x 0.05% = £19.60
Month 3: 40 days x (£980 - £40 + £19.60 = £959.6) x 0.05% = £19.19
Month 4: 40 days x (£959.6 - £40 + £19.19 = £938.79) x 0.05% = £18.77
Month 5: 40 days x (£938.79 - £40 + £18.88 = £917.56) x 0.05% = £18.35
End of month 5: £917 - £40 + £18.35 = £895.91

So you have paid £200 and reduced the debt by £104.09

So, you are £3.91 worse off under the second scheme, and you will be paying interest on that money.

Scale it up to the price of a house, 25 years, 12 months ....

Do you still agree with the bank?

Thrugelmir

Standard method:
Month 1 interest 40 days x £1000 x 0.05% = £20.00
Month 2 interest 40 days x (£1000 - £40 = £960) x 0.05% = £19.20
Month 3 interest 40 days x (£980 - £40 = £920) x 0.05% = £18.40
Month 4 interest 40 days x £880 x 0.05% = £17.60
Month 5 interest 40 days x £840 x 0.05% = £16.80
End of month 5: £840 - £40 = £800

Total interest accrued : £92
Capitalise that, so end of year debt = £800 + £92 = £892

Not a methodology I am familiar with.

Where is the interest at the end of month 1 accounted for?

getmore4less

Thrugelmir wrote: »

Not a methodology I am familiar with.

Where is the interest at the end of month 1 accounted for?

At the end of the year that is what annual capitalise means.

Thrugelmir

getmore4less wrote: »

At the end of the year that is what annual capitalise means.

On an annual basis interest is calculated on the balance owing at the beginning of the period.

Debt: £1000
Interest: 10% per year.
Monthly payment: £40

So interest in following year will £1,000 at 10% = £100.

Five monthly payments at £40 = £200

Balance at end of year = £1,000+ £100 - £200 = £900.

Their method

End of month 5: £917 - £40 + £18.35 = £895.91

Their method is better.

getmore4less

Go back to the first post

This mortgage was sold(described by the lender) to the OP as daily interest annual capitalisation.

that is different to annual interest that you described.

ntadmin

Thrugelmir wrote: »

On an annual basis interest is calculated on the balance owing at the beginning of the period.

Debt: £1000
Interest: 10% per year.
Monthly payment: £40

So interest in following year will £1,000 at 10% = £100.

Five monthly payments at £40 = £200

Balance at end of year = £1,000+ £100 - £200 = £900.


Their method is better.

However, interest is calculated daily. That means, after each monthly payment, it should go down, as tghere is less debt to pay interest on the following month, as per the numbers in the 'standard method' example

ntadmin

getmore4less wrote: »

Go back to the first post

This mortgage was sold(described by the lender) to the OP as daily interest annual capitalisation.

that is different to annual interest that you described.

Well, that's what I thought.