SONIA Compounding: The Complete Guide for UK Borrowers 2026

If you have a UK commercial loan, a revolving credit facility, or any floating-rate debt taken out after 2021, it almost certainly references SONIA — the Sterling Overnight Index Average. Yet many borrowers cannot explain exactly how their interest is calculated each month, what the lookback period means for their payments, or how to compare their floating rate against a fixed alternative.

This guide explains all of it, without unnecessary jargon.

What is SONIA?

SONIA is the overnight interest rate at which UK banks lend to each other in the sterling unsecured market. It is published each London business day by the Bank of England at approximately 09:00, reflecting actual transactions from the previous business day.

Unlike LIBOR — which was based on banks' own estimates of what they thought they could borrow at — SONIA is a transaction-based rate. It reflects real trades. This makes it more reliable, harder to manipulate, and more reflective of actual market conditions.

SONIA was chosen as the UK's Risk-Free Rate (RFR) to replace LIBOR following the 2012 manipulation scandal. It became the primary benchmark for sterling floating-rate debt from 2021, when LIBOR was formally discontinued.

How compounded SONIA is calculated

Your loan does not simply pay yesterday's SONIA rate each day. Instead, SONIA is compounded over the interest period — typically one month or three months — and you pay the result at the end of the period. This is called "compounded in arrears."

The compounding formula accumulates each day's SONIA rate with the previous days to produce a single rate for the whole period. In simplified form:

Because SONIA moves over the interest period (it can change any day the BoE moves rates, or as overnight market conditions shift), the compounded rate you end up paying will differ slightly from the SONIA rate at the start of the period. In a falling rate environment, you pay a lower compounded rate than the starting SONIA would suggest. In a rising environment, the reverse.

Lookback period and observation shift

This is the part most borrowers find confusing — and understandably so, because it requires understanding a practical problem.

If SONIA is published each morning, and your interest is calculated from the SONIA rates throughout the period, how do you know how much to pay on the last day of the period before all the rates are in? You cannot pay on the last day of June using a SONIA rate that won't be published until the following day.

The solution is a lookback period. UK loan market conventions typically use a 5 business day lookback. This means the SONIA rate used for, say, 30 June is the rate published 5 business days earlier — approximately 25 June. This gives the lender time to calculate your exact interest payment and give you advance notice before the due date.

Observation shift is a variation used by some lenders, particularly in the syndicated loan market. Rather than simply looking back, it shifts both the SONIA rate and the number of days it applies by the same lookback period. The practical difference for most borrowers is minimal, but it affects the exact day-count weighting if you are doing precise calculations. Your facility agreement will specify which method your lender uses.

Worked example: £10m loan at SONIA + 200bp

Let's make this concrete with a real-world example that mirrors a typical UK commercial property loan.

The annualised equivalent interest on this loan — if SONIA stays flat at 3.71% — would be approximately £571,000 per year. If the BoE cuts twice more as the market expects, taking SONIA to approximately 3.23% by year-end, the annualised cost would fall to roughly £523,000 — a saving of £48,000 annually.

SONIA vs LIBOR: what changed

For borrowers who had loans originated before 2021, understanding the transition from LIBOR to SONIA matters for two reasons: legacy documentation may still reference fallback provisions, and the economic difference between the two rates is real.

The key practical difference for borrowers is that LIBOR was known at the start of each interest period — you knew your payment on day one. SONIA is known only at the end, after the period has passed and the daily rates have been compounded. This creates more payment certainty under LIBOR and more economic accuracy under SONIA.

Comparing your floating rate against a fixed swap

The most important decision for any SONIA-linked borrower is whether to hedge. An interest rate swap converts your floating SONIA + margin into a fixed all-in rate for the duration of the swap term. You continue to pay SONIA + margin to your lender; the swap dealer pays you SONIA and you pay the fixed swap rate to the dealer — netting to a fixed all-in cost.

Common questions