When getting ready to purchase a home, you probably have questions about the associated expenses. How much interest will I pay on my mortgage? How much will the loan cost me in total? How are mortgage payments calculated?
Principal and Interest
Principal and interest are the two main components of each mortgage payment you make.
Principal
The initial loan amount, exclusive of interest, is known as the principal. Let’s take an example where you put down $50,000 in cash to buy a $350,000 house. That indicates that you are taking out a loan from the lender for $300,000 principal, which you will have to repay over the course of the loan. The interest component of your payment, however, represents the fee the bank charges for lending you those funds.
Interest
Using our example again, let’s say the loan is a mortgage with a 20-year term and an interest rate of 4% per year. Due to the fact that you are paying monthly payments instead of annual ones throughout the year, the 4% interest rate is divided by 2012 and multiplied by the remaining principal amount on your loan. In this case, $1,000 in interest ($300,000 x 0) would be included in your first monthly payment. 04 annual interest rate ÷ 12 months).
If you enter the purchase price, down payment, loan term, and annual percentage rate (more about this is covered under “Interest Rate vs. Entering “APR”) into the Investopedia Mortgage Calculator will show you that your loan payments would come to $1,432 each month. 25. As we previously mentioned, the first $1,000 of your payment only pays the interest; the remaining $432 25 is paying down your outstanding loan balance or principal.
Of course, other expenses that are not paid to the lender, like escrow property taxes and mortgage insurance, are not included in the example above.
How Amortization Works
If you have a fixed-rate loan, you might be wondering why your mortgage payment doesn’t change from month to month. Theoretically, a decreasing principal balance is multiplied by that interest rate. So shouldn’t your monthly bill get smaller over time?.
That isn’t true because lenders use amortization to determine your payment, which helps to maintain consistency in your monthly bill. Because of this, the majority of your monthly payment is interest in the initial years, with the remaining amount going toward principal reduction.
Example of Amortization
Relying on our previous example, your loan payment after 15 years will remain the same if you don’t refinance. But by now, you’ve chipped away at your principal balance. 15 years from now, the principal amount owed on your loan would be around $193,000.
Multiplying $193,000 by the interest rate (0. 04 ÷ 12 months), the amount due for interest is now just $645. 43. But a larger percentage of the principal—$786—is being paid off. 82 of the $1,432. 25 monthly payment is going toward the principal.
The monthly payments for the 30-year mortgage are displayed in the table below at different points. Over the course of the loan, you’ll notice that the principal portion of your monthly payment rises while the interest portion decreases.
| Mortgage Loan Amortization With Principal and Interest Breakdown | |||
|---|---|---|---|
| Year | Principal | Interest | Monthly Payment |
| Year One | $432.25 | $1,000 | $1,432.25 |
| 15 Years | $786.82 | $645.43 | $1,432.25 |
| 20 Years | $960.70 | $471.54 | $1,432.25 |
| 30 Years | $1,427.49 | $4.76 | $1,432.25 |
In the final year of your mortgage, the majority of your payments are principal, with very little interest. Lenders are making your payments easier to manage by distributing them evenly. You would have to make much larger monthly payments immediately after taking out the loan, and those amounts would drastically decrease at the end of the repayment period if you paid the same amount in principal over the course of the loan.
For those who are curious about the amount they will pay in principal versus interest over time, the Investopedia Mortgage Calculator provides a breakdown of payments over the course of the loan.
Adjustable-Rate Mortgages
Throughout the term of your loan, your total monthly payment will not change if you take out a fixed-rate mortgage and only pay the amount owed. As more of your payment is applied to the principal, the amount of your payment that is attributed to interest will gradually decrease. But the total amount you owe won’t change.
For borrowers who take out an adjustable-rate mortgage (ARM), however, things don’t operate that way. Throughout the first term of the loan, they pay a certain interest rate. But the mortgage “resets” to a new interest rate after a predetermined amount of time, say one year or five years, depending on the loan. Usually, when you first borrow money, the interest rate is set lower than the market rate and rises after the reset.
Suddenly, you’ll notice that your monthly payment has changed. This is because a different (often higher) interest rate is being applied to your outstanding principal.
Interest Rate vs. APR
The annual percentage rate (APR) is a term you might encounter when receiving a loan offer. It’s critical to recognize the difference between the actual interest rate that the lender is charging you and the annual percentage rate (APR).
In contrast to the interest rate, the annual percentage rate (APR) accounts for the entire cost of borrowing money each year, which includes costs like mortgage insurance, discount points, loan origination fees, and some closing costs. It takes the average of all borrowing expenses over the course of the loan.
It’s critical to understand that your interest rate, not the annual percentage rate, determines your monthly payment. However, in order to give you a more realistic idea of how much you’re really paying to borrow that money, lenders are obligated by law to reveal the APR on the loan estimate they provide after you submit an application.
APR comparisons of various loan offers are more comprehensive since some lenders may offer you a lower interest rate but higher upfront costs. Since related fees are included in the APR, the actual interest rate is lower than the APR.
How Is My Interest Payment Calculated?
Since you are making monthly payments, lenders multiply your outstanding balance by your annual interest rate and divide the result by 12. Therefore, if your mortgage balance is $300,000 and your interest rate is 4%, you will initially owe $1,000 in interest each month ($300,000%20x%200). 04 ÷ 12). The remaining portion of your mortgage payment goes toward principal.
When a mortgage is amortized, borrowers can continue to make fixed loan payments even as their remaining balance decreases. Initially, the majority of your monthly payment is applied to interest, with only a tiny portion going toward principal reduction. At the end of repayment, that changes so that a larger portion of your payment goes toward lowering your balance due and only a small portion goes toward interest.
What’s the Difference Between Interest Rate and APR?
The amount that the lender actually charges you as a percentage of the loan amount is known as the interest rate. In contrast, the entire cost of borrowing can be expressed using the annual percentage rate, or APR. Thus, costs like mortgage insurance and loan origination fees are included in the annual percentage rate (APR). Certain loans have a low interest rate at first, but additional fees drive up the annual percentage rate (APR).
The Bottom Line
Most likely, you are aware of the monthly payment amount you make to the mortgage servicer. However, it can be confusing to figure out how that money is split between principal and interest. Actually, all it takes to calculate your interest payment is to multiply your interest rate by the amount of money you owe and divide the result by 12. The only reason your payments have remained remarkably constant over the years is that lenders have changed the amount credited to your original loan balance. Article Sources: Investopedia mandates that authors cite original sources to bolster their claims. These consist of government data, original reporting, white papers, and conversations with professionals in the field. When appropriate, we also cite original research from other respectable publishers. You can read more about the guidelines we adhere to when creating impartial, truthful content in our
- Consumer Financial Protection Bureau. “Loan Estimate Explainer.“
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FAQ
How do you calculate interest and principal amount?
Interest = Principal x Rate x Time. Where Principal is the initial amount invested. Time is the length of the investment, and rate is the interest rate that is applied.
How do you calculate principal or interest?
How do you calculate a loan’s principal and interest? You multiply the principal amount by the interest rate and the number of years you have to pay back the loan to get the interest. Divide the interest amount by the product of the interest rate and the loan term in years to determine the principal.
What is the formula to calculate interest on a loan?
How to calculate simple interest. The following formula can be used to determine your total interest: principal loan amount x interest rate x loan term = interest.
What is 6 interest on a $30000 loan?
As an illustration, the interest on a $30,000, 36-month loan at 6% is $2,856. If the same loan ($30,000 at 206%) were repaid over 2072 months, the interest would be $5,797%. Naturally, even slight adjustments to your rate have an effect on the total amount of interest you pay.
Read More :
https://www.investopedia.com/calculate-principal-and-interest-5211981
https://www.bankrate.com/loans/personal-loans/how-to-calculate-loan-interest/