How Is Mortgage Interest Calculated?
When you take out a mortgage, the lender charges interest on the outstanding principal balance. Understanding how this works can help you make smarter decisions about your home loan.
How Mortgage Interest Is Calculated Monthly
Your monthly mortgage interest is calculated using the following formula:
Monthly Interest = Outstanding Principal × (Annual Interest Rate ÷ 12)
For example, if you have a loan balance of $300,000 at a 6.5% annual interest rate:
- Monthly rate = 6.5% ÷ 12 = 0.5417%
- Monthly interest = $300,000 × 0.005417 = $1,625
What Is Amortization?
Amortization is the process of paying off a loan through regular scheduled payments. Each payment covers both interest and a portion of the principal. In the early years of a mortgage, most of your payment goes toward interest. Over time, as the principal decreases, more of each payment goes toward reducing the principal.
The Amortization Formula
The fixed monthly payment (M) is calculated as:
M = P × [r(1+r)^n] / [(1+r)^n - 1]
Where: P = Principal loan amount, r = Monthly interest rate, n = Total number of payments
How to Pay Less Interest
- Make extra principal payments: Even small additional amounts reduce your principal faster, saving significant interest over the loan term.
- Choose a shorter term: A 15-year mortgage has a higher monthly payment but much less total interest than a 30-year loan.
- Refinance when rates drop: If interest rates fall significantly, refinancing can lower your rate and total cost.
- Larger down payment: A bigger down payment means a smaller loan balance and less interest overall.
Use our Mortgage Calculator to estimate your monthly payment and total interest for different scenarios.