Interest Rate Calculations PDF

Terms for subsection: H. Interest rate calculations Term: 01. Interest calculated annually Interest calculated annually Annual rest was method of interest calculation used by most lenders until late 1990s and still used by many lenders today Interest calculated at start of each year and debited to a...

Terms for subsection: H. Interest rate calculations Term: 01. Interest calculated annually Interest calculated annually Annual rest was method of interest calculation used by most lenders until late 1990s and still used by many lenders today Interest calculated at start of each year and debited to account in advance Monthly payments credited to account over the year After 12 months following year’s interest is debited to the account Main benefit of this method is simplicity but there are a number of drawbacks for the borrower Mainly that it does not reduce the capital debt during the year Late payers treated in same way as those who pay early Only way an early payer can benefit is by making advance payments to account just before end of accounting year or make a part-capital repayment If making a part-capital repayment borrower needs to specify this so the payment is treated as such Otherwise computer will treat the credit as a regular payment so the capital reduction will not be applied Late payers are only penalised if outstanding payments at end of accounting period Variation of annual rest is monthly rest Makes adjustment to account each month to take account borrower repayments This was used by one mainstream lender (Burnley BS) many years ago but practically obsolete now Recommended Reading: Accounting Methodologies Lloyds TSB - How interest is calculated Coventry Building Society – How is Interest Calculated Term: 02. Interest calculated daily Interest calculated daily Daily rest adopted by increasing number of lenders in recent years Standard way of calculating interest on many other products including most credit cards With this method interest calculated daily on outstanding balance So computer debits 1/365 of annual interest every day with reference to total debit balance that day Effect is that mortgage can be reduced more quickly by making regular overpayments Late payers are penalised as daily interest debited on higher balance than would have applied if repayment had been made on time Generally accepted as a fairer method as lender only charges interest on the balance In contrast annual rest does not take into account reductions from monthly payments during the accounting period Rates on most flexible mortgages are calculated daily Term: 03. Mortgage payments under annual review Mortgage payments under annual review Some lenders give the borrower the opportunity to fix monthly payments for the whole year even if the mortgage rate is variable Fixed payments credited to account through the year Regardless of whether interest rates change or not At the end of the year account will be over or underpaid and an adjustment will be built in to the following year’s payments Annual review originated when building societies were main lenders in market As they are mutual organisations many used this system to reduce the need to send out interest rate notifications to borrowers each time there was a rate change Rather, the notifications could be sent with notice of annual general meeting which has to be sent to all members by law Annual reviews removed uncertainty for the borrower with regard to monthly outgoings Can be attractive for those who do not wish to gamble on a fixed rate However, if there are many rate rises during the year this will have a large upward impact on the payment the following year A further disadvantage is that borrowers do not gain immediately from reductions in interest rates They have to wait until the next review for rate reductions to be reflected in their payments These schemes should not be confused with annual reviews on life policies including endowments