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How it works


So what does a 6% interest rate mean in real life? It means that every year they charge you 6% of the amount they have loaned you. Percent being "per 100", this means that for every 100 pounds you borrow, they want 6. So to work it out for 100,000 quid, you work out how many 100 pounds you have borrowed and multiply it by 6:

------- X 6 = 6,000

But, of course, that is over a year. Nearly all lenders work your interest out monthly, so they divide the interest rate by 12 and work out the figures every month. So in this case, 6% / 12 is 0.5%, so every month you owe them:

------- X 0.5 = 500

In fact, some work it out daily, but you get the idea. It really is that simple. Well, it is if you aren't interested in actually paying the loan off. We'll get back to that later.


As well as charging interest, banks also like to charge you for other services like administration fees for opening the account, getting a discount, breathing their air, looking at them in a funny way etc. Having got your mortgage, you'll stagger out of the bank feeling like you've been mugged.

So what stops an unscrupulous lender offering a really low interest rate to tempt people in, and then slapping loads of extra charges on to make up for it? Well, nothing except that by law they have to show their interest rate in terms of APR (and we're not talking about an air purifying respirator here). In short, the APR is the equivalent amount of interest you'd be paying if all the charges you have to pay were collected by adjusting the interest on your loan. It reflects the total cost of the loan so comparisons between loans are valid, no matter what the charges and interest rates are. So a loan with an APR of 6.5% is going to cost you more than one with an APR of 6%, even if the first loan has an interest rate of 4% (and huge stonking fees) and the second one a rate of 5% (with fewer fees).

The only problem is that a lot of mortgages come with discounts that range from 1 year to the whole life of the mortgage. This really messes up the APR comparison idea and I'll tell you how later on.

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