Mortgages: Look behind the headline rate

Nearly five years since the majority of lenders made the switch to daily interest, almost 20 lenders still calculate new mortgages on an annual or monthly interest basis.

Halifax announced that interest on all new mortgages would be calculated on a daily interest basis in 2001. Existing customers were also offered the opportunity to transfer to daily interest at the end of any special deal.

Why is Daily Interest Important?

When interest is calculated on a daily basis, any payments made are applied directly on to the account, immediately reducing the debt and the amount of interest chargeable. This means the overall amount paid back by the end of the loan is reduced saving the borrower money.

For example, a borrower with a £200,000 mortgage on a standard variable rate of 7.00% and interest calculated on a daily basis would repay a total of £421,689 over 25 years. A £200,000 mortgage at the same rate calculated on an annual interest basis would repay £429,054 – almost £7,500 extra over the life of the mortgage.

If the interest is calculated on an annual basis, the lender will make their calculation on the total outstanding balance at the end of the previous year. Any payments made during the year, will simply sit on your account until this interest calculation has been applied, therefore not reducing your debt until the end of the period. Similarly, on a monthly interest mortgage, any payment made on the first of the month will not be applied until the last day of the month.

Mark Heaton, head of mortgages at Halifax, said: "The clear message for borrowers is 'look beyond the headline rate'. Your mortgage should be offering you the best possible long term value. Daily interest saves customers a lot of money over the life of their mortgage and should not be overlooked when they are looking at which deal is the best for their circumstances."