There are essential two ways a
lender can charge interest. One is by Monthly rest,
which will be dealt with on the previous page to this
one and the other is Annual review and it is this way we
will explain here on this page.
Please note the graph below is not accurate and is for
illustrative purposes only.
Unlike monthly rest with annual review interest is
calculated and charged annually.
There are some downsides to this.
One is, if rates change in a downward direction you may
not reap the benefit until the end of the year when your
rate is reviewed. However that said if rates rise the
lender may not pass that rise onto their customers until
their rate review at the end of the year.
Another is to do with repayment mortgages. If you have a
repayment mortgage and interest is calculated annually
you could end up paying more in interest over the term.
The reason for this is, if the lender calculates the
interest at the beginning of the year based on the rate
that they are charging and based on the outstanding
balance at the time, that calculation will not take into
consideration that the balance will reduce throughout
the year due to capital repayments.
An example of this is a £100,000 mortgage, in month one
you will pay interest due on the amount and make your
payment however by month 10 you might only owe £99,000
but you will still be paying the same interest
attributed to the £100,000 debt that was calculated at
the beginning of the year.
By the end of a 25 year mortgage term this discrepancy
on a repayment mortgage can be quite significant.
This is not to say that all lenders that operate annual
review actually pre-calculate interest in this way but
it is a question that you should ask either your
mortgage advisor or your lender direct.
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