Understanding Compound Interest

TheJP

N6xxy said:

Sorry I think it's my understanding. When I think of a fixed mortgage I believe you pay a fixed amount each month incorporating the agreed interest and when i say variable i mean following an amount above the BOE base rate so it's changeable. 

I thought compound interest meant that you accrue a daily interest charge each day until a payment is made, so my logic being if you paid £1 each day, that interest would not accrue?

If this was the case then no one would be in the hardship they currently face. Are you perhaps drinking the logic...

ElwoodBlues

N6xxy said:

Sorry I think it's my understanding. When I think of a fixed mortgage I believe you pay a fixed amount each month incorporating the agreed interest and when i say variable i mean following an amount above the BOE base rate so it's changeable. 

I thought compound interest meant that you accrue a daily interest charge each day until a payment is made, so my logic being if you paid £1 each day, that interest would not accrue?

You accrue interest each day on that days balance, regardless of whether a payment is made. If you pay off £1 each day then the interest will be based on the balance of £1 less than it was the day before (plus the day's interest, which is likely to be more than £1). With an interest rate of 4.48%, the interest saving on each £1 you pay off is going to be a whopping 4.48 pence per year (0.012 pence per day on average).

Compounding just means there is interest on the interest, calculated daily. That's whay you have a daily interest rate and an annual interest rate which is very slightly different, because the compounding is factored into it.  Basically, because of compounding, the earlier you make an overpayment, the bigger the interest saving will be.

You do pay a fixed amount each month, but the interest each month is different, because the balance is (hopfeully) reducing. The bank works out the total cost of the loan over it's term (capital plus the interest), and then divides it by the number of months in the term, to give you a regular monthly repayment amount. Note that that gets recalculated each time something changes on the mortgage (e.g. a fixed term ends, product transfer etc), so you monthly payment won't stay constant throughout the entire mortgage term (unless you have a lifetime fix).

The other important thing to note is that because the repayments are fixed, but the interest decreases with the balance, at the start of the mortgage, your payments will be mostly insterest, and little capital each month. As the mortgage goes on and the balance reduces, you're same monthly payment will be reducing the balance faster.