We all know that getting a mortgage is all about finding the most competitive interest rate available on a suitable deal, but what isn’t always obvious is exactly how that rate impacts your monthly repayments.
In this short guide we look at how lenders calculate mortgage interest on different types of product, and answer the most pressing FAQs about mortgage calculations.
How frequently is interest calculated on a mortgage?
On the vast majority of fixed-rate mortgages, interest is calculated on a monthly basis but on many variable rate deals it’s calculated daily. However, regardless of the frequency of calculations, they are based on your remaining mortgage balance, and the mortgage repayments are still made monthly.
How it is calculated per month
Monthly mortgage interest is calculated on the remaining balance of your mortgage times the interest rate you’re currently on. However, while it may seem like this would reduce your monthly payment as the mortgage is repaid over time, this isn’t the case due to amortisation.
Amortisation is where mortgage lenders apply the same monthly repayments over the full mortgage term. At the beginning of your borrowing, a larger portion of your monthly repayment goes towards interest and less towards the loan. As time goes on, you pay more towards the loan, as the amount of your monthly repayment needed to cover the interest owed gradually reduces.
How daily interest is calculated
To find the daily interest rate lenders divide the annual interest rate by 365. This figure is then timed by the balance remaining each day to calculate the interest owed that day. Daily interest is then typically added to the mortgage balance once a month, as mortgage repayments are almost always made monthly, despite how often the interest is calculated.
How often is interest calculated on an offset mortgage?
With an offset mortgage your interest is typically calculated on a daily basis. However, mortgage repayments are still paid monthly. This means that you’ll usually benefit from the interest saved from the previous month when you make your next repayment.
How an interest-only mortgage is calculated
On an interest-only mortgage interest is calculated in the same way as any other mortgage, however, as you are not repaying any capital, you continue to pay interest on the full loan for the duration of the mortgage term. Unlike with amortisation, your full monthly repayment is used to cover the cost of the interest you owe every month.
At the end of the mortgage term you still need to repay the mortgage balance, as you have not repaid any of it through your monthly repayments.
How interest is calculated on a lifetime mortgage
Interest on a lifetime mortgage is not calculated in the same way as any other mortgage, as you won’t need to repay any of the interest in your lifetime. This means that your interest is typically (but not always) rolled up, or ‘compounded’.
How compound interest works
With compound interest, interest owed is added to your loan balance and the following month you will pay interest on the new balance, including last month’s interest. And so on.
This means that the balance will continue to rise incurring interest on top of interest each month until you pass away. At this point the lender recoups their money through the sale of your property.
If you have an questions or concerns about your mortgage interest rate, get in touch and we’ll refer you to an adviser who can address your queries.