The secret mortgage trap that costs you thousands

More than a sixth of all mortgage lenders are still calculating interest charges in an outdated method that adds thousands of pounds to the cost of their loans, research published today shows.

Moneyfacts, the personal finance data analyst, said 20 mortgage lenders still calculate interest on an annual basis on some or all of their products, ignoring most of the monthly repayments made by lenders each year. Most of the lenders charging annual interest are smaller building societies, but the list includes two large mortgage providers, Bristol & West and Portman Building Society.

Annual interest calculations penalise borrowers because lenders work out how much is owed in charges for the following 12 months on the basis of the outstanding mortgage at that date. Each subsequent repayment made reduces this balance, but borrowers continue to pay interest calculated with reference to the larger amount.

Moneyfacts said the cost of the annual interest method was £8.68 a month on the average £130,000 mortgage, or £2,604 over the term of the loan, assuming an interest rate of 5 per cent. The extra charges equate to an additional 0.10 percentage points on top of the headline rate of interest.

Most lenders have abandoned annual interest calculations, switching instead to daily or monthly charges. For borrowers who make monthly repayments, the majority of mortgage customers, these two calculation methods produce the same results.

Julie Harris, a mortgage analyst at Moneyfacts, said annual interest calculations were an additional hidden charge that many borrowers did not recognise.

"If you have battled through the minefield of mortgage options, interest types, rates, fees and other terms, there is one final piece of the jigsaw," Harris said. "Many borrowers may be unaware of this trap but it could cost them thousands of pounds in additional interest charges."

A spokeswoman for Portman Building Society confirmed the lender still calculated interest annually on all but one of its mortgages. She said the practice would be reviewed after the vote on the society's proposed merger with Nationwide later this year. A spokeswoman for Bristol & West said it also planned to review the use of interest calculations.