Interest rates

Interest-Ed

Hi - I was just trying to get my head around mortgage interest rates and how they are calculated.

If you are borrowing say £1000 over 1 year is the amount you pay monthly worked out by dividing the £1000 by 365 days then the interest calculated on the daily amount.

For example this would mean you'd by paying £2.74 per day plus interest of say 6% which would be 45p. = £3.19 per day.

Or is it that the first day the rate is worked out on 365 days, the second day against 364 days etc.

Does anyone understand what I mean? Because I'm now totally confused.

lisyloo

Hi Ed,

Not sure I quite understand what you mean but I think your first explanation is nearer the mark.

When you are charged interest you are just charged for THAT month.

Or is it that the first day the rate is worked out on 365 days, the second day against 364 days etc.

I don't think it is like this. You only pay for one month at a time.

e.g. lets say you owe £100,000 and you pay on 1st Jan in advance for January and you pay 5% gross.

The interest paid for January would be

£100,000 * 0.05 / 365 * 31 = £424.66

Note that the ACTUAL interest charge on your account varies montly because the number of days in the month varies butthe lender will charge you a fixed amount which will even out over the year for convenience.

There is no forward charging of interest e.g. paying for the rest of the year, which is what you seemed to be suggesting in your second suggestion.

There is a difference between gross and AER interest rates, but we'll leave that for today.

Interest-Ed

Thanks Lisyloo. I appreciated your calculation.

I'd thought about it too much and got myself confused. I think I should have asked how interest calculated daily differs from interest calculated monthly (and how the calculation would be made)

I'm in the process of re-mortgaging after a fixed period and was trying to create an excel spreadsheet to work out the best ways of paying a £100,000 mortgage
in the shortest period of time - ie what would it cost over 10 years if I could throw extra cash in if and when I had it!

Don't know if anyone has any thoughts on this - (other than 'you must be mad' or 'you'll be lucky!'.

lisyloo

OK, lets start with annual.
If you take out an annual mortgage then in the first year you will pay £100K multilplied by your mortgage rate.
The payments you make during the year will not be counted, you will still pay interest on the original £100K.
This is really bad and to be honest a bit of a rip off but don't write it off entirely because it's possible you might find an annual interest mortgage with a great rate and low fees.

You need to take everything into account when comparing mortgages and not just one factor.

Lets move onto monthly.
In month 1 your debt will be £100K, so you will pay interest on that.
In month 2 your debt will be £100K minus the repayment part of your payment (your monthly payment on a repayment mortgage consists of 1 months interest put an amount to reduce the capital).
As an example in month 2 you might be charged interest on £99750 because you paid off £250 in month 1.

With daily interest the amount on which you are charged interest is taken into account daily. This means that is you make an additional payment on Monday then you will pay less interest on Tuesday. This is clearly better than monthly or annually because you are getting the benefit immediately.

However, as I say, don't get blinded by this.
You need to take into account rates and fees.
If you can get a good rate annually then you might be better taking it and putting your savings in a cash ISA, especially if your overpayment won't exceed £3K which is the ISA limit.

You should not choose your mortgage on one factor alone.
Hope that helps.

Interest-Ed

Lisyloo - thanks for that information. The more I read the clearer the picture gets. I think I'm looking at options with more confidence than previous years - especially as the current Bank is not giving too much time for me to make a decision on this year's offerings from them - I would probably make a panic decision normally.

Regards