THE bitter battle raging amongst mortgage lenders, desperate to grab a bigger slice of the market, is spreading confusion among borrowers.
|Pistols at dawn: the battle between lenders is spreading confusion|
No sooner have they managed to come to terms with the complexities of fixed rates, capped rates, discounts than lenders have changed all the rules. Borrowers have been landed with a whole new list of options such as base rate trackers, current account mortgages and new-style standard variable rates that leave everyone on SVR discounts out in the cold.
If this were not enough to cope with, borrowers are now also having to grapple with the relative merits of daily and annual interest rates.
The way interest is calculated now differs not just between lenders, but also between products in the same lender's range. Cheltenham & Gloucester, for example, charges 6.75 per cent if you want your interest calculated on a daily basis, but 6.6 per cent if you are happy to stick with annual interest.
The Halifax, meanwhile, has introduced a daily interest loan at 6.75 per cent. But unless borrowers specifically ask to be switched, they will remain on a 7.5 per cent annual interest deal. Similarly, from April 25, Abbey National will let borrowers switch to its tracker loan, currently charging 6.75 per cent, if they specifically request a move.
Britain's biggest building society, Nationwide, slashed its standard variable rate to 6.45 per cent a few weeks back which sounds like the best deal of the lot. But, according to the Halifax, it is not as good as it looks because the Halifax charges daily interest and Nationwide annual interest (although its systems are being updated to switch to daily interest soon). Last week, Yorkshire Building Society entered the fray by lopping its daily interest rate to 6.45 per cent - the cheapest deal of any.
The real question arising out of all this is: does it really matter whether interest is calculated daily, monthly or annually? And the short answer appears to be yes. For some borrowers it matters to the tune of tens of thousands of pounds.
When building societies began back in the dark days of Victorian England, mortgage accounts were calculated manually. This was very time-consuming, so it was done only once a year. On a given date, the money owed on each borrower's account was reckoned up and multiplied by the prevailing rate of interest, to establish how much interest needed to be paid over the coming year. This figure was then divided by 12 to give the monthly instalments.
When mortgage lenders became computerised towards the end of the last century, interest calculations were still made on the same basis. But until recently, quite generous tax concessions meant there was no real incentive to repay a loan early. However, now that the taxbreaks have been removed, there are much better arguments for getting shot of a mortgage as soon as possible.
This changing climate has put the spotlight on the major drawback of annual calculation. Repayments made during the course of the year are not taken into account until right at the end, which means borrowers do not immediately benefit from reducing the size of the loan. The interest rate continues to be based on the loan outstanding at the end of the previous year.
This is particularly important for borrowers who wish to overpay a little each month, or make a substantial one-off reduction in their balance. However, to be fair, most so-called "annual rest" lenders will recalculate interest on request if a large deposit is made.
According to Abbey National, someone taking out a £60,000 daily-interest mortgage who overpays £50 each month will save £16,995 in interest and repay the mortgage five years eight months early. Similarly, a £5,000 deposit in year five would save £12,068 in interest and the loan would be repaid three years, six months early.
But even if no repayments are made early, a daily-interest loan is still cheaper. This is because the debt is reduced on a monthly basis. To put it simply, with a daily loan you owe less in February than you did in January, and less again in March and so on. Therefore you pay less interest overall.
This explains why C&G introduced a higher headline rate for daily borrowers than annual ones, as both types of borrower should both end up paying roughly the same.
Borrowers need to know how much cheaper a daily rest loan is compared with the annual alternative. But the answer is a lot more complicated than the question.
To start with, it depends how long your mortgage has been running. With a repayment loan, you are largely repaying interest at the outset, but the amount of capital (ie, the actual loan) you pay off increases during the term. This means the debt is reducing faster towards the end of the mortgage. With a daily loan, it will reduce faster still as the years go by.
According to the Halifax the difference on the headline rate is negligible during the early years. The bank originally considered introducing two different rates a la C&G, but subsequently rejected the idea when it worked out that, for the first seven years, a daily loan is between 0.07 and 0.10 per cent cheaper.
Given that seven years is the typical life of a mortgage, the difference for most borrowers, and therefore the cost to the lender, is not huge.
Halifax is technically correct when it says Nationwide's new rate is not as good as it sounds because it adjusted annually, but it is still better than the Halifax's daily rate. If you allow for the distorting impact of the more expensive annual interest rate, the building society's rate is still just 6.55 per cent. And the value will be even greater when Nationwide introduces daily interest for all borrowers later this year.
But it is when you come to the latter years of the loan that the picture distorts more dramatically. The Halifax claims that, for the last five, or possibly 10, years of a 25-year loan, the difference could be as high as 0.45 per cent, depending on interest rates. If Nationwide stuck with annual interest for the next 25 years, this increases its rate to 6.9 per cent.
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