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There are two parts to a mortgage repayment: the principal and the interest. You pay back both the money you borrow (the principal) and the interest (charged by the lender). This interest adds up to a huge chunk of money on top of your original loan amount. Some lenders calculate your interest charges daily, or monthly.
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Interest on your home loan is generally 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).
Assuming you have an outstanding loan amount of $500,000 and an interest rate of 3.00% p.a., your interest repayment for one day would be calculated using the following formula:
To work out the monthly interest charges, multiply the daily interest charge by the number of days in the month.
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.
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.
The following factors will affect the amount of your interest repayments:
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, and they basically mean that one portion of your repayment goes towards paying off the amount you borrow and another portion 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.
In our hypothetical case study, Susie is borrowing $700,000 to buy a house. Like most borrowers, she wants to save as much money on interest repayments as she possibly can. After comparing home loans with 100% offset accounts, Susie decides to calculate just how much difference a 0.25% p.a. difference in interest rates could make to the total cost of a loan.
If she can find a loan with an interest rate of 3% p.a. on a 30-year loan term, her monthly principal and interest repayments will be $2,951. The total interest she will end up paying over the life of the loan is $362,442.
But if Susie finds a loan with a marginally lower interest rate of 2.75% p.a., her monthly repayments will be $2,858 – a saving of $93. The total interest over the life of the loan will be $467,051.29 — that’s a total interest saving of $33,480.
Now that you know a bit more about how interest is calculated let's look at the ways you can actually pay less of it.
5 tips to pay off your mortgage faster
Image: Shutterstock
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