Annual And Daily Interest Mortgages

Should you go for a mortgage where the interest is calculated annually or daily?

House prices will still continue to rise during 2005, but not at the rate of previous years. The Royal Institution of Chartered Surveyors predict a 3% increase in house prices in 2005, but when you consider that prices rose 13% in 2004, this illustrates a market slowdown. With average UK house prices at £178,906 at the end of 2004 due to a market boom for several years, it has become very expensive to buy a property. That is why you need to make cost savings wherever you can.

If you understand the difference between fixed and variable mortgages then you are well on your way to being clued up about mortgages and understanding which would be most affordable to you. Another thing that you should look out for on your mortgage hunt is whether the lender calculates the interest rate daily or annually, as you could potentially save yourself thousands of pounds in interest every year.

What does this mean?

A mortgage lender charges you interest for lending you the money to buy a home. This can either be at a fixed rate or variable rate, depending on which type of mortgage feels right for you. The actual amount of interest you pay every month depends on:

1. The mortgage rate, obviously.

2. The way the interest is calculated.

Mortgage lenders will calculate interest in one of two ways; either as an annual interest mortgage or a daily interest mortgage. The differences that each can make to your pocket are explained below:

Annual interest mortgages

This is the traditional method used by mortgage lenders such as banks and building societies to calculate how much interest you have to pay them every month. They only work it out once a year. For example:

Your outstanding mortgage balance is 85,000 at the end of 2004. The interest you have to pay in 2005 would be calculated by taking this amount and multiplying it by your daily interest rate:

= 85,000 X (6%/365 days)

The main disadvantage is that no matter how many repayments you make during the year, these are not taken into account. You are actually paying too much interest which could amount to thousands of pounds as they are charging you based on your balance at the end of last year. Also if you make overpayments some lenders may not recognise this until the year end so there is no point in doing it!

Daily interest mortgages

Daily interest mortgages do the opposite in that they charge you interest based on what your balance is every day. So if you make a monthly repayment the amount of interest you pay will decrease as your balance is decreasing.

For example your balance at the start of the year was 85,000. Then you make a mortgage payment of £500 at the beginning of February taking your balance to 84,500. Your balance is reduced automatically the next day using a daily interest mortgage. For example:

84,500 X (6%/365days) is the calculation they would use, rather than 85,000

This makes daily interest mortgages far fairer as the amount of interest charges is worked out on your daily balance, not your annual one. This could save you a few thousand pounds in interest charges just in one year alone. Also if you make overpayments then you can reduce the term of your mortgage considerably. Instead of paying it off for 25 years you could find it all done and dusted within 20.

You should always ask the lender how they calculate their interest rates as opting for a daily interest mortgage could prove to be very financially rewarding for you.