Compound interest explained Unless you choose to do so, there are no repayments to make on a lifetime mortgage until the plan comes to an end. As a result, a lifetime mortgage is subject to compound interest. Compound interest is different to the interest added to a residential mortgage or personal loan. How does it work?
interest already accrued), not just the amount you initially borrowed. This means a larger amount of interest is added to your lifetime mortgage every period. And this cycle continues until the plan ends. Without making payments, this can significantly reduce the equity remaining in your home and leave you with limited financial options in the future. This could mean you're unable to remortgage to a cheaper product in years to come, reduce your ability to privately fund any future care costs, or restrict your options to move home in the future.
With a lifetime mortgage, interest is added either monthly or annually depending on your plan. During that first month or year, interest is charged and added to the amount of money you’ve borrowed, otherwise known as your initial loan amount. The amount of interest added will depend on your initial loan amount and interest rate. If you’ve had a residential mortgage or personal loan in the past, you’ll know the interest added is based on the amount you originally borrowed. But with a lifetime mortgage, that’s not the case. Instead, the interest is calculated and charged on what you owe (your initial loan amount plus the
An example of how compound interest accrues over 20 years Balance at the start of year Interest (6.3% MER) 1 Balance at the end of year 2
Remaining property equity 3
£82,475 £87,824 £93,519 £198,778 £272,153
£5,349 £5,695 £6,065
£87,824 £93,519 £99,584
£200,176 £194,481 £188,416
Year 1 Year 2 Year 3
This cycle continues for the life of the plan
£12,891 £17,649
£211,669 £289,802*
£76,331
Year 15 Year 20
£0
This example is for illustrative purposes only and uses the average release amount of £82,475 and monthly equivalent rate (MER) of 6.3% – Key Market Monitor H1, 2023. Average UK house price of £288,000 – ONS, August 2023. 1. Interest rate: The rate at which interest is applied to the loan – in this case, monthly (MER). With all Key lifetime mortgages, your interest rate is fixed for life. This column shows how much interest has been added to the loan that year 2. Balance at the end of the year: How much is owed at the end of the year, including compound interest 3. Remaining property equity: The difference between how much your property is worth and the outstanding balance of your lifetime mortgage * Although the balance at the end of the year is higher than the property's value, you'll never owe more than your home's worth with a Key lifetime mortgage thanks to the no negative equity guarantee. Read more about this on page 25.
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