Daily interest miscalculation?

danm

Marvin_the_Martian wrote: »

That strikes me as a rather artificial interpretation: by that token you might as well argue that if you overpay, the interest is really less than 6%!

Implicitly on a balance of 100,000 i would pay less than 6% (but only because the overpayment has reduced the base on what the interest is charged)

[Deleted User]

danm wrote: »

Implicitly on a balance of 100,000 i would pay less than 6% (but only because the overpayment has reduced the base on what the interest is charged)

I think I've managed to answer my own question. I found this:

http://en.wikipedia.org/wiki/Nominal_interest_rate

So it seems that this sort of thing is not uncommon in lending. Ah well.

danm

Marvin_the_Martian wrote: »

I think I've managed to answer my own question. I found this:

http://en.wikipedia.org/wiki/Nominal_interest_rate

So it seems that this sort of thing is not uncommon in lending. Ah well.

Forgive me if im wrong, but the tone of your email suggests that you feel lenders are doing somthing wrong.

The way they do it (as opposed to the way you have been doing it) is better for you....

just wanted to clear that up.

I can knock up a spreadsheet in a couple of minutes to show the calculations for you. PM me if you want it

[Deleted User]

danm wrote: »

Forgive me if im wrong, but the tone of your email suggests that you feel lenders are doing somthing wrong.

Well, I think that it wouldn't hurt if lenders were clearer about how they calculate the interest they charge.

The way they do it (as opposed to the way you have been doing it) is better for you....

just wanted to clear that up.

But not quite as good as if the rate quoted were the effective interest rate, as opposed to a nominal one, though. Before today I hadn't come across this "nominal interest rate" notion.

I can knock up a spreadsheet in a couple of minutes to show the calculations for you. PM me if you want it

I can see what you're saying - it's plain that being charged interest daily is better than having interest calculated for the entire month on the balance as it was at the beginning of the month (or worse, for the entire year). I do think however that lenders could be a little clearer about how it does work.

InMyDreams

Marvin_the_Martian wrote: »

But not quite as good as if the rate quoted were the effective interest rate, as opposed to a nominal one, though. Before today I hadn't come across this "nominal interest rate" notion.

But it *is* the actual interest that they charge. What you want them to declare is the notional one which just wouldn't be relevant because no-one just leaves their mortgage to grow and grow like that, year on year. In the same way an AER is a notional interest rate for savings accounts that pay interest monthly. But that is very relevant because many people will leave their savings to grow year on year and want to be able to make direct comparisons to yearly paying savings accounts. You don't get mortgages that only charge you interest yearly, so there's no need to make up a notional interest rate for those that charge monthly.

If the problem is that you want to compare to a savings product, then you need to look at savings products that pay monthly and look at the actual interest paid (ie the gross - any tax payable) not the notional AER.

PS... if you wanted to compare your mortgage to a yearly paying savings account, then you'd have to create your own new type of notional interest rate. Um, an MER... monthly equivalent rate????? for the savings account

The 'effective' rate you ask for is notional, based on you not touching the money. Since no-one manages their mortgage like that, surely it wouldn't be right of the banks to advertise it.

InMyDreams

Marvin_the_Martian wrote: »

InMyDreams wrote: »

But you wouldn't normally pay interest on the interest on a mortgage. It is calculated daily, but like with monthly paying savings accounts, it is only added on monthly. With a savings account, it's only once it's added onto your account that you start to earn interest on the interest (ie it's calculated daily but only compounded monthly). With a mortgage, you clear the interest each month before it's had a chance to do any compounding. As you clear the interest each month, by the end of the year you will have only paid your 4.95% because you haven't had to pay interest on the interest.

But wouldn't you still end up paying 11 months' interest on the first monthly interest charge, ten months on the second, and so forth...?

I'm not sure I follow you. If you pay off your interest each month (as everyone should, even those on IO) then no, you wouldn't end up paying 11 months interest on that amount because you don't owe it any more. That's what I meant by clearing it so it won't have a chance to compound.

I guess there is an exception to all this. I'm assuming everyone is paying off at least the interest each month. Those on a payment holiday wouldn't be, I guess. The effect of this would indeed be, as you say, an apparent rise in interest rate due to the compounding effect of now paying interest on the interest that they haven't cleared. But it's this new, 'effective' rate that is the notional one you want advertised. The real reason that you appear to be paying a higher rate is that you are still paying the 4.95 rate but on a higher balance. If you still want to use £100,000 in your calculations, then you have to fiddle the interest rate to have the same 'effect'.

[Deleted User]

InMyDreams wrote: »

But it *is* the actual interest that they charge.

It's the nominal interest rate they charge. The effective interest rate is somewhat higher.

What you want them to declare is the notional one which just wouldn't be relevant because no-one just leaves their mortgage to grow and grow like that, year on year.

One might as well argue that the interest rate they do quote is equally irrelevant, as I don't have an interest-only mortgage.

In the same way an AER is a notional interest rate for savings accounts that pay interest monthly. But that is very relevant because many people will leave their savings to grow year on year and want to be able to make direct comparisons to yearly paying savings accounts. You don't get mortgages that only charge you interest yearly, so there's no need to make up a notional interest rate for those that charge monthly.

If the problem is that you want to compare to a savings product, then you need to look at savings products that pay monthly and look at the actual interest paid (ie the gross - any tax payable) not the notional AER.

PS... if you wanted to compare your mortgage to a yearly paying savings account, then you'd have to create your own new type of notional interest rate. Um, an MER... monthly equivalent rate????? for the savings account

Nowhere have I mentioned savings products. I don't know why you assume that I want to make such a comparison.

The 'effective' rate you ask for is notional, based on you not touching the money. Since no-one manages their mortgage like that, surely it wouldn't be right of the banks to advertise it.

And no-one manages a repayment mortgage in the way you've outlined, so your example is equally fictional.

[Deleted User]

InMyDreams wrote: »

I'm not sure I follow you. If you pay off your interest each month (as everyone should, even those on IO) then no, you wouldn't end up paying 11 months interest on that amount because you don't owe it any more. That's what I meant by clearing it so it won't have a chance to compound.

I guess there is an exception to all this. I'm assuming everyone is paying off at least the interest each month. Those on a payment holiday wouldn't be, I guess. The effect of this would indeed be, as you say, an apparent rise in interest rate due to the compounding effect of now paying interest on the interest that they haven't cleared. But it's this new, 'effective' rate that is the notional one you want advertised. The real reason that you appear to be paying a higher rate is that you are still paying the 4.95 rate but on a higher balance. If you still want to use £100,000 in your calculations, then you have to fiddle the interest rate to have the same 'effect'.

Actually, if I owed £100,000 and took a payment holiday for twelve months, at a declared annual interest rate of 4.95%, I would indeed expect to have an outstanding balance of £104,950 at the end of the year no matter whether that rate was calculated quarterly, monthly, daily or by the second. That, in my perhaps incredibly naive view, is what an annual interest rate of 4.95% means: the rules of mathematics don't change depending on the type of product you're talking about.

Yes, it's probably a nitpick. As I've acknowledged in a previous post it still works out better than if I were being charged a nominal rate of 4.95% on some other basis, or charged a rate of 4.95% on the initial balance for an entire year. No, I don't expect them to change their advertised rate. I acknowledge that a nominal interest rate is an accepted way of presenting a product. What I would like is for lenders to show their working - even if it's in the fine print or buried in the handbook. They do this well enough in the case of the fees they charge, but not the interest, it seems.

danm

no you wouldn't, as the mortgage balance (principal + outstanding interest) in month 2 is higher, so you would pay more interest in the second month. (obviously this may differ between lenders).

From your Wiki, the only bit to worry about, is the small part on 'Simple Interest'. Nominal rates/efffective rates are not relevant. The 'headline' rate and the APR are all that matters with mortgages

InMyDreams

Marvin_the_Martian wrote: »

It's the nominal interest rate they charge. The effective interest rate is somewhat higher.

But it would only be 'effective' to those people not paying off their interest which will be a very small minority. The 'actual' interest rate is the one they advertise and the one you pay over the year, whether on repayment or interest only. This is what you pay on whatever balance is outstanding.

Marvin_the_Martian wrote: »

No, they're declaring the nominal interest rate. I would like them to declare the effective interest rate - even if it were only in "small print", as it were. And you might as well argue that the interest rate they do quote is equally irrelevant, as I don't have an interest-only mortgage.

Whether you are on repayment or interest only makes no difference to the rate of interest. You pay on what is outstanding. If you are on repayment, that balance goes down each month so you pay less (in interest), but you are still paying the same rate.

Marvin_the_Martian wrote: »

Nowhere have I mentioned savings products. I don't know why you're assuming I want to make such a comparison.

My apologies. I was thinking about savings products because that is another area where notional interest rates (AER) often causes confusion. I appreciate you didn't mention them. I was trying to help but I won't mention them again.

Marvin_the_Martian wrote: »

And no-one manages a repayment mortgage in the way you've outlined, so your argument is equally fictional.

???? *Everyone* pays a repayment mortgage like that. That's how they are calculated, but it's worked out for you. Each month you clear the whole amount of interest accrued, plus a bit off the capital. As you pay more off the capital, the balance goes down so the interest accrued the next month is a bit less, but because the actual amount you pay is the same, it allows a little bit bigger chunk to be paid off the capital. That is precisely why in the early years the balance doesn't go down by much but later on the proportion of your payment that is interest reduces so the balance comes down faster. You might not realise that you are doing it, but that is what you are doing. You clear the interest each month so you don't end up paying interest on that.