Portman building society has what appears to be the best two-year fix at 4.3%. But if you have a repayment mortgage, Yorkshire building society’s deal at 4.38% for two years is cheaper over the fixed term because Yorkshire calculates interest on a daily basis, while Portman does it once a year.
The interest on mortgages always used to be worked out on an annual basis, but most lenders now calculate it daily or monthly. With a repayment loan, part of your monthly payment goes towards reducing the outstanding capital, so there is less interest to pay each month. With daily and monthly interest calculations you benefit from this immediately, but if the lender adjusts interest annually you don’t — the interest you pay is determined by your balance at the start of each year.
The Sunday Times is calling for all lenders to switch to daily or monthly interest calculations — and it has the backing of leading mortgage analysts.
Simon Tyler at Chase de Vere Mortgage Management, a broker, said: “Daily interest is without doubt the fairest system. Most lenders have switched over to daily interest during the past few years. But others are stubbornly refusing. It can make a mockery of best-buy tables because the monthly costs on a repayment loan with annual interest are higher than identically priced deals from lenders who calculate daily.”
Someone with a 20-year £150,000 mortgage fixed at 4.5% for two years would pay £639.93 less in interest over the fixed term if interest were calculated daily rather than annually, according to Yorkshire. He or she would also have paid an extra £308.97 off the outstanding capital.
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If you have an interest-only mortgage, it is irrelevant whether interest is calculated annually or daily because you are not repaying any capital, so the amount you owe does not change throughout the year.
Repayment loans are more popular. According to the Council of Mortgage Lenders, 76% of mortgages taken out in 2004 were repayment.
The financial benefits of daily interest calculation increase with time. In the early years of your mortgage, the difference between daily and annual interest will be just a few pounds rather than hundreds or thousands. This is because the bulk of your monthly payment goes on interest and only a small amount on repaying the capital. But the proportion going towards capital repayment rises slightly every month and by the end of your mortgage term the interest has shrunk so you are paying off mostly capital.
Ray Boulger at John Charcol, a broker, said: “On a 25-year repayment mortgage at a constant rate of 5%, about 11.5% of the amount borrowed is repaid in the first five years, 26% after 10 years, 69% after 20 years and 93% after 24 years. In the final year more than 95% of the monthly payments will be capital. If you are on annual interest, the real interest rate you will be paying during the last year of your mortgage will be approximately double the quoted rate.”
Daily interest is also important if you make regular overpayments. Melanie Bien at Savills Private Finance, a broker, said: “If you want to overpay regularly find out how the interest is calculated. If it is annually, any overpayments are unlikely to be deducted from the mortgage balance until the end of the year — regardless of when you make them. So you would be better off leaving the money in a savings account until the end of the year and earning interest on it.”
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Some lenders that charge annual interest will take overpayments into account immediately, but only if you notify them. And often you have to overpay by at least £500.
Portman is one of the largest lenders still using annual interest, although it has one flexible product that calculates interest monthly. The society says it has no plans to transfer its other deals to monthly interest.
Matthew Wyles at Portman said: “You get greater transparency with annual interest, because you know how much interest you will pay over a year. Sometimes in financial services, transparency is as important as fairness.”
Not everyone agrees, however. David Hollingworth at L&C Mortgages, a broker, said: “I don’t think the fact that you are paying capital off every month but are paying interest based on what you owed at the beginning of the year is something many people would call transparent or fair.”
Other lenders that still charge annually include Lambeth, Nottingham, Leeds and Saffron Walden building societies.
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Some brokers believe one of the main reasons lenders still use annual interest is to get into the newspaper and internet best-buy tables. The Sunday Times’s best-buy mortgage tables take interest calculations and fees into account, but not all do.
Mark Chilton at Purely Mortgages, a broker, said: “Annual interest adds about 0.1 points to the cost of the loan, so lenders that use it actually have a market advantage and that’s not fair. Some lenders are clearly using it to get into the best-buy tables. Portman’s two-year fix at 4.3% is equivalent to a daily interest rate of 4.41%, which would not top the best buys.”
Melanie Green at Which?, the consumer lobbyist, said: “A lot of people don’t realise that interest can be calculated in different ways so they just look for the lowest rate. But the rate is only one element of a bigger picture and you need to look at how much a mortgage will cost you over the period you think you will have it.”
Which? has an online calculator at switchwithwhich.co.uk that enables you to work out the total cost of individual mortgage products. Alternatively, a broker will be able to help you.
BIG PAY-OFF
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ADELE HAMMOND and her husband, Steven — pictured (in the print edition) with their two sons Jamie, 6, and Ben, 4 — remortgaged on to an offset tracker from First Direct in October.
The deal they are on was an exclusive from L&C Mortgages and they are paying 0.19 points above base rate for 18 months, currently 4.69%, after which the rate is 0.75 points above base for a further 18 months. There are no early-repayment charges and First Direct calculates interest daily.
Adele, 38, said: ‘We want to pay off our mortgage as quickly as possible, so daily interest is really important. We overpay every month, and are already noticing that our mortgage is coming down.’