Everyone knows that taking out a mortgage may mean paying back many thousands of pounds more in interest than the capital they borrowed in the first place. Fewer people know that the amount of interest depends on how the capital repayments are calculated. Nic Cicutti explains the different methods.

Twenty years or so ago the choice of mortgage available to most borrowers was simple. To paraphrase Henry Ford, you could either have a repayment loan, or a repayment loan.

This is the kind of mortgage where each year into the loan you repay a mixture of interest and capital. Gradually, the capital repayments increase relative to interest until by the end, most of the monthly payments involve the loan itself.

In the 1980s everything changed. Lenders introduced the interest-only loan, backed by a separate investment - typically an endowment policy, but also PEPs and tax-free pension lump sums.

However, fears over whether endowments can pay off the entire loan in a low-inflation climate have led to the resurgence of direct repayment options. If nothing else, their supporters argue, repayments offer the certainty of meeting the full cost of the mortgage over the agreed period.

But the return in popularity of repayment options has also led to a fierce debate over how each monthly payment should be calculated against the loan itself.

A survey by Harris Research for Yorkshire Bank earlier this year suggests that a third of people have no idea when their mortgages will be fully paid off, and more than 50 per cent have no idea what their exact repayments are or how they are calculated.

Typically, mortgage lenders will calculate the amount of capital to be repaid only at the end of a 12-month cycle, no matter how much has been repaid in the intervening period. This is known within the mortgage industry as the "annual rest" period.

In effect, it means that borrowers who repay their mortgages each month are themselves loaning money to their lenders throughout the year, until their repayments are credited against the amount still outstanding.

The alternative is to credit part of the amount paid against the capital owed, as soon as it comes in, either monthly ("monthly rest") or daily ("daily rest").

Research by Yorkshire Bank, which operates the daily rest system, shows what that means. The bank calculates that if borrowers' monthly repayments were immediately set against the capital owed, savings of thousands of pounds in interest could be achieved.

On a typical pounds 50,000 loan, repaid monthly at today's rate of 8.45 per cent, monthly repayments of pounds 373.74 would give total interest savings of pounds 4,459 over 25 years. Or the repayment period could be cut by 10 months.

Yorkshire Bank allows payments to be made fortnightly. With such a system, the interest saved compared to other lenders would be pounds 5,600, lopping 14 months off the repayment period. Weekly repayments would give savings of pounds 6,312, or 15 months off the typical period.

Direct Line, the telephone insurer which now also offers mortgages and has a variable rate of 7.59 per cent, also operates daily rests. Over 25 years, its loans would give total interest savings of pounds 7,533 compared to the rate that is charged by most lenders.

Lenders are increasingly sensitive to suggestions that their charging system is unfair. Some, while still operating an annual rest system, argue that they are prepared to be flexible to help people pay off their loans early.

Andrew Stinson, from Barclays Mortgages information unit, says: "We are prepared to allow people to make lump sums reductions of pounds 1,000 or more on standard variable mortgages, without penalty, and payments will be adjusted downwards the following month to take the lower capital owed into account.

"We are also ready to show flexibility with people who have fixed-rate mortgages, allowing them to pay up to twice their normal monthly payments, thus reducing the term of the mortgage." Mr Stinson suggests that it may be possible both to make one-off capital repayments and to increase monthly pay- ments in order to cut the loan period.

Ian Darby, marketing director at John Charcol, the mortgage brokers, argues that flexibility is key to the right mortgage.

"What people are really looking for is the chance to pay off their loan faster than the original limit. This may be for many reasons, including coming into lump sums, perhaps as a result of bonuses.

"We try to offer a range of mortgage that impose no redemption penalties for people who wish to make partial repayments, be they fixed-rate or capped mortgages." John Charcol also offers new-style flexible mortgages which allow for payment holidays and swifter repayments at borrowers' own discretion.

Which?, the consumer magazine, this month publishes a guide to checking your mortgage statement, which includes a list of lenders operating monthly or daily rests. Obtaining a copy could help you shave thousands off your loan.

Nic Cicutti, personal finance editor, has written a 27-page 'Guide to Mortgages', available free to readers of 'The Independent'. The guide, sponsored by Barclays Mortgages, is available by calling 0800 585691. Or fill in the coupon on page 4.