How is Interest Calculated on a Mortgage Loan?

How is interest calculated on a mortgage loan? Questions regarding interest rate calculations is one of the most frequent questions from homeowners. There are a number of different ways to calculate interest on a mortgage loan. It is imperative to understand the different methods for calculating home mortgage interest, because those calculation methods define when the mortgage is paid in full and the amount of each monthly mortgage payment.

The most commonly used mortgage payment plan is known as the fully amortized loan. With this type of calculation, the payments are made toward the mortgage loan on a constant basis. The most typical arrangement is a monthly mortgage payment. Funds are applied first to the interest owed on the loan then the remaining amount of money from the payment is applied to the balance of the loan principal. Over the course of the loan, the amount of interest and the principal mortgage balance owed are reduced. To calculate the amount of interest owed, you would need to multiply the loan balance by the annual interest rate. This gives you the amount of the annual interest owed on the loan. To determine the monthly mortgage interest, you would divide the annual mortgage interest by 12 months.

So, for example, with a $100,000 home mortgage loan at 8% over 30 years; with a monthly payment of $733.76; you would multiply $100,000 by 8%; which is $8000. Next, to determine the amount of monthly mortgage interest owed on the mortgage loan, you simply divide the annual interest ($8,000) by 12 months; which is $666.67. To find out how much of the monthly mortgage payment is being applied toward the principal of the mortgage loan, deduct the monthly interest owed from the monthly mortgage payment. $733.76 - $666.67 = 67.09. This means that for the first month of the mortgage $67.09 will be applied toward the $100,000 mortgage balance and $666.67 will go toward interest.

During the second month of the mortgage, the calculations will be somewhat different because the balance of the mortgage loan has changed; it has been reduced by $67.09. Instead of multiplying by $100,000 you would now use $99,932.91 ($100,000 - $67.09) All other calculations will remain the same. Every month of the length of the mortgage the amount of money applied toward interest will be reduced while the amount of money applied toward principal will be increased.

When the amount of money applied to the principal of the mortgage loan equals or exceeds the amount of money paid toward interest; the principal of the loan begins to be reduced at a much more rapid rate. In the above example, this would occur with the 257th payment, during year 21 of the mortgage.

Understanding how is interest calculated on a mortgage loan can help homeowners make better financial decisions and assist them in planning for their financial futures.