Are there any benefits to interest rates being compounded monthly for lifetime mortgages?

Monthly compound rates can be misleading and lenders should agree to a standard way of illustrating their calculations, say our experts

All lifetime mortgages have a monthly or annual equivalent rate, the critical factor is what is used to calculate the interest. How the interest rate is compounded – whether this is monthly or annually – will affect the amount of interest rolled up and repaid upon sale of the property.

Interest rates on lifetime mortgages need to be illustrated on a consistent basis so customers and advisers can compare like with like. The annual rate – or for those compounding monthly, the annual equivalent rate – is what should be shown in comparative tables.

The industry should adopt a uniform approach to this and the most consumer-focussed way of doing it would be to illustrate rates on an annual basis. The following table illustrates this point, taking the example of a mortgage of 75,000 over 15 years:

If you decided to take a mortgage on the headline rate advertised by the lenders then lender B in the above example would be the natural choice at 6.15%, but as the table shows this would cost the client 2,114 more in interest over 15 years. The true cost of a lifetime mortgage can only be assessed by comparing APRs and this must be the acid test. Cashback will not be shown in an APR calculation.

Other than for marketing purposes, and perhaps the systems capabilities of some lenders, there is little benefit in having a monthly compounded rate. Indeed one could go as far to say that that is misleading and hides the real cost to the consumer. My vote is for an annual rate as the industry standard. This is an area that has often been written about in the past and highlighted as being something advisers should watch out for. The details are often buried deep within the Key Facts Illustrations of providers.

In some cases, it is unclear what the interest rate basis is even from the KFI. Looking at the APR gives the best indicator though even this does not necessarily provide enough information as the fees included could be over- contributing to the APR.

Ultimately, it is the APR that provides the real comparison, anyway. That said, the issue of a monthly rate as against one being compounded annually cannot be ignored.

The actual rate, whether calculated monthly or annually, is not the point. The important thing is how clear this is to the adviser and the consumer.

Rates can easily be converted to show how they compare. But if all rates were displayed on a like for like basis it would make life easier for everybody.

Our advisers are provided with clear comparisons of all the available rates so that they can see the real basis the provider uses, and also the annualised rates for those that are monthly.

The only reason for having a monthly charging method is to deflate the headline figure to make it look more competitive. By now I would have expected lenders to have started to move away from this tactic.

It is ultimately the consumer who may be misled by lower looking monthly compound rates and thus make the wrong choice. Now is the time for lenders to agree to show rates in a uniform way to make life easier for everybody.

Researching this market is tough enough as it is.