Looking beyond headline interest rates

When UK borrowers are looking around for a mortgage deal, they can often be swayed by what seems a low initial interest rate. But there’s much more to a mortgage than the headline interest rate. Although most people don’t think about it, the question of how your mortgage interest is calculated is a very important one.

When you’re looking at mortgage product features, check for a line that says ‘interest calculated daily’. You won’t find it on every mortgage deal, but if you do it could save you thousands. In the last five years, most mortgage lenders have switched to calculating interest daily, but there are still quite a few – almost 20 – who still use a monthly or annual calculation – and that could cost borrowers dearly.

Here’s how it works. With daily interest, when you make a payment, it is applied directly to the account. That means your debt goes down immediately and with it the amount of interest that will be charged. By the end of the loan term the amount that must be paid back is much lower, saving you money.

If the standard variable rate is 7 per cent and you have a mortgage of £200,000, you would repay £421,689 over 25 years with a daily interest calculation. However, with interest calculated annually, you would repay almost £7,500 more at £429,054. The annual calculation charges interest based on the balance at the end of the previous year, so no matter how many payments you have made, the interest will not be recalculated and your debt won’t be reduced till the end of the year. The same principle applies to a monthly interest calculation.

Borrowers need to look out for long term value, so it is essential to look beyond what the interest is to how the interest is calculated. Doing your homework before taking out a mortgage could mean more money in your pocket.