Mortgage calculator
Written by Steve Wentworth
Friday, 9th October 2009
Introduction
This article provides some guidance on how mortgage lenders in
the UK calculate your mortgage payments. There are no set rules defined by the
Finacial Services Authority (FSA ), however lenders must be accurate on the
illustrations and mortgage offer documents they supply to you.
How interest is charged
Mortgage lenders use a number of different methods for charging
interest, these methods fall into one of three categories: -
-
Daily interest charging.
-
Monthly interest charging.
-
Annual interest charging.
Annual interest charging
The most simplest of these is the annual interest charging
method, this is certainly the oldest method adopted by lenders. Interest is
charged at the start of the year based on the mortgage balance figure. This
interest amount is then divided through the 12 months of the year for each
payment for an interest-only mortgage or combined with capital for each payment
if a full repayment mortgage.
Interest-only calculation
So with a balance of £100,000 and a rate of 6.5%: -
Full repayment calculation
so with a balance of £100,000 and a rate of 6.5%: -
Monthly interest charging
With monthly interest charging, the annual interest rate is
first divided by 12 to establish a monthly interest rate. This new monthly
interest rate is then applied to the mortgage balance to calculate a monthly
interest charge for each payment on an interest-only mortgage or combined with
capital for each payment if a full repayment mortgage.
Interest-only calculation
So with a balance of £100,000 and a rate of 6.5%: -
Full repayment calculation
so with a balance of £100,000 and a rate of 6.5%: -
As you can see there are benefits to having a monthly interest
charged mortgage over an annually charged one if your mortgage is a full
repayment mortgage as this example shows a saving of £8 per month.
Daily interest charging
Many mortgage lenders in the UK have now adopted daily interest
charging methods, this method is far more complicated and many lenders have
their own rules on how they calculate daily charges of interest. Therefore for
the purpose of this article the following method will be used, this should
provide a guide to how much savings can be made with a daily interest charging
method. In order to calculate the daily rate of interest we start with the
annual interest rate and divide this through by 365.25 days (0.25 being the
leap year). We must then multiply this by the days in any particular month.
However you do not make mortgage payments every single day so these charges are
rolled up and charged to you on a monthly basis. The main benefit with daily
interest charging comes when you make over-payments reducing your mortgage
balance immediately benefiting from lower interest being charged. Daily
interest charging is often used with flexible mortgages, offset mortgages and
current account mortgages as these present huge benefits to the borrower.
Dealing with rate changes
Most of today's mortgages start of with a special offer rate
for a period of time then the mortgage often reverts to the lenders standard
variable rate. For example a 4.5% fixed for 2 years followed by the lenders
standard variable rate currently 5.6%. How do you calculate what payments will
be in 2 years time once the special rate period has expired? Simply put you
just start over using the new balance, and remaining term. So based on an
original loan amount of £100,000 and mortgage term of 25 years
Interest-only mortgage
then mortgage payments after the first 2 years will increase to: -
Full repayment mortgage
In order to calculate the new mortgage payments after the first 2 years we must
first calculate the new balance as capital will have been paid for 24 months: -
Now we have a balance for 2 years in the future we can start
over with a new balance and a 23 year term: -
Lenders will use a similar process to this when a variable rate
changes during the term of the mortgage. They will first inform you of the rate
change and then calculate the balance and start over with the remaining term,
balance and new rate.
About the author
Steve Wentworth formed his firm
Wentworth Financial Services in Nov 2007 having been in the industry since Nov 2002.
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