The SARON is a short-term interest rate (overnight rate) which has a term of one day. SARON mortgages require longer interest terms – terms of one month or three months, for example.
These longer-term interest rates based on the SARON are called the compounded SARON (the SARON rates plus compounded interest). To determine the compounded SARON, lenders calculate the daily SARON rates across an observation period (three months, for example) and apply the result to the interest period.
In other words, the compounded SARON would be equal to the annualized return of an investment with compounding interest earned at the SARON overnight reference rate over a specific observation period. The compounded SARON is calculated from the daily SARON rates across the observation period.
A task force of the Swiss National Bank laid out different methods for calculating the compounded SARON. Swiss lenders can choose between seven different compounded SARON calculation methods:
- Plain: Calculation and billing of interest at the end of each interest term.
- Payment Delay: Calculation of the interest rate at the end of the interest term. Interest is billed some time afterwards.
- Lockout Period: Interest is billed at the end of the interest term. Calculation of interest is done some time before.
- Lookback: Interest is billed at the end of the interest term. Interest is calculated some time before. The observation period used to calculate interest is identical in length to the interest term but begins ahead of the interest term and ends before the interest term ends.
- Last Reset: Interest is billed at the end of the interest term. Interest is calculated and determined at the start of the interest term. The observation period is identical in length to the interest period but begins and ends before the interest term starts.
- Last Recent: Interest is billed at the end of the interest term. Interest is calculated and determined at the start of the interest term based on a short observation period.
- Interest Rollover: A provisional interest rate is calculated and determined at the start of the interest term. If the real rate deviates from the provisional rate during the interest term, the difference is applied in arrears.
With most calculation methods, the compounded SARON is only known at the end of the interest term. Variants 5 (Last Reset) and 6 (Last Recent) are exceptions to this rule. With variant 7 (Interest Rollover), a provisional interest rate is determined at the start of the interest term, but the difference between the provisional and real rates are corrected in arrears.
More on this topic:
SARON mortgage guide
SARON explained
