When applying for a mortgage you might be intrigued by interest only mortgages as their low monthly repayment rates seem to beat most other types of mortgage hands down. Looking at an interest only mortgage calculator as opposed to any other UK mortgage calculator it shows a huge disparity in what you are required to pay back on a monthly basis. But interest only mortgages (even if you have a savings plan in place to pay off the full loan once the mortgage matures) can still cost you more in the long run than a standard repayment mortgage and this is all because of how the interest in calculated.
Firstly, with an interest only mortgage the interest is calculated on the full sum of the loan, rather than a rate which is always reducing. This means that over a 25 year period you will always pay the same amount of interest and your monthly payments will not change. With a full repayment mortgage you will pay more at first, but this amount will reduce as time goes on because the interest calculated will be a smaller amount as the capital investment sum is reduced.
When your interest is calculated can also make a difference as to how much you end up paying. If your interest is calculated daily, each payment you make immediately takes a chunk off of your debt and thus an amount off of your interest. When interest is calculated daily you will find that you end up paying a lot less in the long run.
A monthly calculation means that you have to be careful when you make any payments (in particular overpayments) as this may not show up in your interest calculation until much later in the month. Once it does show up, though, it will be taken off of your debt just like interest which is calculated daily, so it is a simple matter of deciding when to make your payments according to your lenders calculation deadline.
If your interest is calculated yearly you may find yourself giving far more money to the lender than anticipated. Any overpayment still raises interest whether it is being calculated or not and your lender will benefit from the extra interest until it is noted at the end of the year. This money should be going towards paying off your debt and lowering your repayments so really, if you find that your lender calculates interest this way, you should go with another deal.
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