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How lenders calculate interest on your home loan

Lenders charge interest on your home loan every day, using your interest rate and the loan amount to calculate your repayments.

There are 2 parts to a mortgage repayment: the principal and the interest. When you make a repayment, you generally pay back both the money you borrow (the principal) and the interest (charged by the lender).

Lenders calculate your interest charges daily or monthly, and it can surprise people to find out that the interest part of your repayments can add up to a huge chunk of money on top of your original loan amount. In fact, based on the current average annual loan value of $600,000, on a 30-year loan and an interest rate of 5.3%, you'll pay around $600,000 interest on top of your loan amount of $600,000. That's right – a total of $1.2 million.

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How is home loan interest calculated?

Interest on your home loan is usually calculated daily and then charged to you at the end of each month. Your bank will take the outstanding loan amount at the end of each business day and multiply it by the interest rate that applies to your loan, then divide that amount by 365 days (or 366 in a leap year).

Home loan interest calculationAssuming you have an outstanding loan amount of $500,000 and an interest rate of 6.00% p.a., your interest repayment for 1 day would be calculated using the following formula:

  • ($500,000 x 0.06) ÷ 365 = $82.19

To work out the monthly interest charges, multiply the daily interest charge by the number of days in the month.

  • $82.19 x 30 = $2,466 monthly interest charge
At the end of the month, each daily interest charge is added together and then charged to your loan. To work out how much your interest repayments will be, input the details of your loan into our home loan interest calculator below.

If my loan principal reduces over time, why do my repayments stay the same?

There are 2 parts to the loan repayment: interest and principal. Lenders spread out the interest charges over time, charging more interest early on. This means you repay less of the principal and more interest.

As time goes on, you pay less in interest and pay off more of the principal. This is called an amortisation schedule.

What factors affect the amount of interest you pay?

  • Reserve Bank official cash rate. The interest rate on your loan is based on the official cash rate set by the Reserve Bank of Australia. The official cost of borrowing can prompt lenders to charge a higher or lower amount of interest. The current cash rate can be found here.
  • Home loan interest rate. This is the rate at which the bank charges you interest on the loan, eg 6% p.a. The RBA cash rate partly determines this, but each bank and lender sets their own rates.
  • The amount you borrow. The larger the sum you borrow from your bank, the more interest you will pay, although some banks also offer discounted interest rates for larger loan amounts.
  • The outstanding loan amount. As you gradually pay off the money you borrow, you will be paying interest on a smaller loan amount and your interest payments will slowly reduce. For example, your interest repayments when you first start paying off a $500,000 loan will be much larger than when you've paid off half of the principal amount, and interest is only payable on $250,000.
  • The number of days in the month. Most lenders calculate interest on home loans daily and then charge that interest to you each month. So, you could pay a smaller amount of interest in February (with 28 days in the month) than you do in March (with 31 days).
  • Loan term. The time you take to pay off your loan will affect the amount of interest you pay. Paying your loan off over a shorter period will minimise your interest repayments.
  • Repayment frequency. Most lenders allow you to make repayments weekly, fortnightly or monthly, so the amount of interest you pay each time will vary depending on your repayment schedule. The more frequently you make repayments, the less interest you will pay on your loan. Use our bi-monthly calculator to see how your interest payments will vary depending on your repayment frequency.

Finder survey: Do Australians of different ages know the difference between a home loan interest rate and comparison rate?

Response75+ yrs65-74 yrs55-64 yrs45-54 yrs35-44 yrs25-34 yrs18-24 yrs
Yes51.16%50.31%67.25%61.84%64.17%57.77%55.71%
No48.84%49.69%32.75%38.16%35.83%42.23%44.29%
Source: Finder survey by Pure Profile of 1112 Australians, December 2023

Principal and interest vs interest-only

There's another factor that can affect your regular home loan repayment amount: whether you are making principal and interest or interest-only repayments. Principal and interest repayments are the most common way to pay off a home loan. They mean that a portion of your repayment goes towards paying off the amount you borrow and another goes to paying off the interest you owe.

However, some loans are designed to allow you to make interest-only repayments for a certain period, for example, if you're building a new home or if you're a property investor with an investment mortgage. This allows you to reduce your regular repayment amount.

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2 Responses

    Default Gravatar
    SHELLEYFebruary 25, 2023

    I NEED TO CALCULATE HOW MUCH MY INTEREST CHARGED AMOUNT PER MONTH IS . WHAT INFORMATION DO I NEED TO DO THIS AND HOW DO I DO IT?

      AvatarFinder
      RichardFebruary 27, 2023Finder

      Hi Shelley,

      If you already have a home loan you should be able to see the breakdown of interest versus principal on your monthly repayments each month. If you want to do a basic calculation for yourself do the following:

      1. Take your interest rate and convert it into a a decimal figure by dividing it by 100. So a rate of 5.00% would become 0.05.
      2. Divide this number by 12 to get a monthly figure. In this case, 0.05 divided by 12 equals 0.004166667.
      3. You multiply this figure by your loan principal (how much you have left to repay on your loan). If your loan principal is $500,000 then 500,000 times 0.004166667 equals $2,083.33. That’s your monthly interest charge.

      Keep in mind this is a simple calculation and doesn’t take into account your loan term, your loan type, loan fees or rate changes.

      I hope this helps.

      Richard

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