How is mortgage interest calculated?
Home loans can seem complex and intimidating. This may be due in part to the enormous sums of money required to buy real estate in Australia’s capital cities in particular. It may also be partly due to the seemingly obscure math involved in calculating your interest fees and monthly repayments.
Your high school math teachers may have included simple compound interest formulas in their curriculum, and even loan interest and amortization formulas. But if your memories of those days are fogged by time and a cloud of hormones, here’s a quick refresher on how mortgage interest and repayments are calculated so you can make your own home loan estimates.
Please Note – RateCity is not a math teacher and should not be used as a resource for students. Check with your teachers, read your textbooks, and always show off your work.
Also, individual banks and mortgage lenders can use slightly different calculations to calculate their interest charges. Always check with a lender about how they calculate your mortgage before signing on dotted lines.
How to Calculate Mortgage Interest
Many banks and other mortgage lenders will calculate your interest daily and will charge you monthly when you make your planned repayment of your home loan.
You can use this formula to find out the interest charged daily on your home loan:
P x (r ÷ n) = A
- A = amount of money – in this case the daily interest charge
- P = principal – the outstanding loan amount on your mortgage
- R = interest rate – Remember, these calculations require your advertised rate to be divided by 100, hence the name “percent” which is Latin for “out of 100”.
- N = duration – Since the interest rates are “per year” or annually (again in Latin), this number should indicate how many of the time units you are looking for occur in a year, e.g. B. 12 months, 26 14 days, 52 weeks etc.
For example, if you had a $ 500,000 mortgage and you are paying 3% annual interest, you can calculate your starting daily interest fee as follows:
$ 500,000 x (0.03 ÷ 365) = $ 41.10
Assuming you are in a month with 30 days, it would mean your lender is roughly charged $ 1233 Interest on your $ 500,000 in the first month.
Remember that as you lower your mortgage capital through monthly mortgage repayments, the daily interest rates you are billed will change.
How to calculate the repayment of your home loan
To find out how much a lender is likely to charge you per month for a home loan, including principal and interest, you can use a slightly more complex twist on the previous formula:
P x (rn) x (1+ (r ÷ n)No ÷ ((1+ (r ÷ n))No -1)) = A
I promise it’s easier than it looks
Using the previous example of a $ 500,000 loan repaid in monthly installments at 3 percent annual interest over 30 years (that’s 360 monthly repayments), it would look like this:
$ 500,000 x (0.0025 x (1.0025)360 ((1.0025)360 -1)) = A
If we whip a calculator to do some of the operations (although you could multiply the parentheses by yourself 360 times …) we get …
$ 500,000 x (0.0025 x 2.4568422115 ÷ 1.4568422115) = A.
What us …
$ 500,000 x 0.004216040337289 = $ 2108.02
This means that with a monthly payment of around $ 2108 for 30 years, you can gradually pay off not only your home loan but also the lender’s interest burden.
While more than half of your initial monthly repayment will be interest expenses ($ 1233 out of $ 2108, based on our previous calculations), that will change over time as each repayment gradually shrinks your mortgage equity.
If you are making additional repayments on your mortgage, e.g. For example, if you receive a tax refund or your floating rate goes down but you continue to make the same higher repayments, these will be used directly to reduce your mortgage equity. The faster you can reduce your capital, the more you can lower your interest costs, which can potentially save you more money and pay off your property faster.
Use a mortgage calculator
Does it all sound too harsh? Would you rather press a button and have it all done for you? Sounds like you could use a mortgage calculator.
These online tools are available from comparison sites such as RateCity, as well as from banks and mortgage lenders. You just need to fill in a few details to get the results, which you can even view as a table of repayments, showing the principal and interest amounts month after month for the entire repayment period. There are a variety of different calculators available for solving various personal finance problems.
Keep in mind that mortgage calculators (and the formulas above) are based on certain assumptions, which means that the results should be viewed as estimates only and may not exactly match what you would pay in real life. For example:
- For example, let’s say you pay the same interest rate for a full 30 year loan period, which is unlikely with a floating rate.
- For example, suppose every year and month has the same number of days when we all know that doesn’t match our calendars.
- Exactly only for the values entered in the calculator and without any fees or additional charges or the effect of additional repayments, offsetting and new withdrawals on your mortgage.
- Different lenders may calculate their home loans differently; B. by rounding some numbers up or down, which can affect the exact amount of the payment.
Talking to a mortgage broker could be a great way to prepare your mortgage calculations before seriously considering a home loan. These home loan experts can calculate the numbers on your behalf and answer any questions about how certain features and benefits of a home loan could affect your payments. And once you’re happy with the numbers, a broker can walk you through the mortgage application process, saving you time and hassle.