How is mortgage interest calculated?


Home loans can seem complex and intimidating. This may be due in part to the huge sums of money involved, especially when buying property in Australian capitals. It may also be partly due to the seemingly impenetrable calculations involved in calculating your interest charges and monthly repayments.

Your high school math teachers may have included simple interest and compound interest formulas in their curricula, and even loan and repayment interest formulas. But if your memories of those days are cloudy with time and a cloud of hormones, here’s a little reminder on how mortgage interest and repayments are calculated, so you can make your own mortgage estimates.

Please note that RateCity is not a math teacher and should not be viewed as a source for students. Check with your teachers, read your textbooks, and always show off your work.

Additionally, individual banks and mortgage lenders may use slightly different calculations to calculate their interest charges. Always check with a lender how they calculate your mortgage before signing on dotted lines.

How to calculate mortgage interest

Many banks and other mortgage lenders calculate your interest daily and bill you monthly when you make your scheduled mortgage repayment.

You can find out the interest on your mortgage every day using this formula:

P x (rn) = A

  • A = amount of money – in this case, the daily interest
  • P = principal – the amount of the loan still due on your mortgage
  • R = interest rate – keep in mind that to be used in these calculations, your percentage of the advertised interest rate must be divided by 100, hence the name “percent” which means in Latin “out of 100”.
  • N = duration – Since the interest rates are “per year” or annual (in Latin again), this number should be the number of time units you are looking for in a year, e.g. 12 months, 26 fortnights, 52 weeks, etc.

For example, if you had a mortgage of $ 500,000 and you were paying interest at a rate of 3% per annum, here’s how you might calculate your initial daily interest charge:

$ 500,000 x (0.03,365) = $ 41.10

Assuming you’re in a month with 30 days, that would mean your lender will charge you around $ 1233 interest on your $ 500,000 the first month.

Keep in mind that as you reduce your mortgage principal by making mortgage payments each month, the daily interest you are charged will change.

How to calculate your mortgage repayments

To find out how much a lender will likely charge you per month for a home loan including principal and interest, you can use a slightly more complex variation of the previous formula:

P x (rn) x (1+ (r ÷ n)m ((1+ (r ÷ n))m -1)) = A

I promise, it’s easier than it looks.

So, using the previous example of a $ 500,000 loan to be repaid in monthly installments at an annual interest rate of 3% over 30 years (i.e. 360 monthly repayments), this is what it would look like:

$ 500,000 x (0.0025 x (1.0025)360 ((1.0025)360 -1)) = A

Taking out a calculator to handle some of the operations (although you CAN multiply the parentheses by themselves 360 times…), we get…

$ 500,000 x (0.0025 x 2.4568422115 ÷ 1.4568422115) = A

Which gives us…

$ 500,000 x 0.004216040337289 = $ 2108.02

This means that by paying around $ 2,108 per month for 30 years, you will be able to gradually pay off not only your home loan, but the lender’s interest charges as well.

While more than half of your initial monthly repayment will be interest charges ($ 1,233 out of $ 2,108, based on our previous calculations), this will change over time as each repayment gradually reduces your mortgage principal. .

If you make additional payments on your mortgage, such as when you get a tax refund, or if your variable interest rate drops but you continue to make the same higher payments, they will directly reduce your principal. mortgage. The faster you reduce your principal, the more you can lower your interest charges, which can save you more money and help you pay off your property sooner.

Use a mortgage calculator

Does it all seem too hard to you? Would you rather press a button and have it all work out for you? Looks like you could use a mortgage calculator.

These online tools are available from comparison websites like RateCity, as well as from banks and mortgage lenders. All you need to do is enter a few details to get the results, which you can even view as a repayments spreadsheet, with the principal and interest amounts shown month by month for the entire loan term. There are a wide variety of different calculators available for solving different personal finance issues.

Keep in mind that mortgage calculators (and the formulas above) are based on certain assumptions, which means the results should only be taken as estimates and may not be exactly what you would pay in a lifetime. real. For example:

  • Assuming you will pay the same interest rate for a full 30 year loan term, which is unlikely if you have a variable interest rate.
  • Assuming every year and month has the same number of days, when we all know it doesn’t fit our calendars.
  • Being accurate only for the values ​​entered into the calculator, and not including any additional fees and charges, or the effect of any additional, cleared and withdrawn repayments on your mortgage.
  • Different lenders may calculate their home loans differently, such as rounding some numbers up or rounding others down, which could affect exactly how much you will pay.

Talking to a mortgage broker could be a good way to prepare your mortgage calculations before you seriously think about a mortgage. These mortgage experts can calculate the numbers on your behalf and answer any questions you have about how certain features and benefits of the mortgage loan might affect what you pay. And once you’re happy with the numbers involved, a broker can help you through the mortgage application process, saving you time and hassle.


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