If you’re looking to own your own home or refinance an existing loan with another bank, the first thing you usually need to consider is the mortgage. The most important part of a mortgage is the principal and interest included in your monthly payments.
Part of the monthly payment you make to the lender goes toward repaying the original loan amount, while another part goes toward paying interest. Although we can easily see the results using a mortgage calculator, figuring out exactly how the monthly payment is calculated can be quite a hassle. You might also wonder why your monthly payment remains the same even as the outstanding balance decreases. However, if you understand the basic concept of how lenders calculate repayments, the process is much simpler than you might think.
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Key Points
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Table of Contents
Principal and Interest
Every mortgage payment you make consists of two main parts: principal and interest.
Principal
The principal is the original loan amount, excluding any interest. For example, let’s say you buy a house worth $3,500,000 and make a down payment of $500,000. This means you have borrowed $3,000,000 in principal from the lender. You will need to repay this $3,000,000 over the term of the loan.
Interest
However, the bank won’t lend you $3,000,000 for free. The bank charges a fee on these borrowed funds, and this fee is the interest on the repayment. The interest is calculated based on the interest rate provided by the bank.
How Are My Interest Payments Calculated?
Let’s assume our loan is a 30-year mortgage with an annual interest rate of 4%. Since you make payments monthly, not annually, the 4% interest rate is divided by 12 and then multiplied by the outstanding principal of the loan. In this example, your first month’s payment will include $10,000 in interest ($3,000,000 x 0.04 annual interest rate ÷ 12 months).
If you enter the purchase price, down payment, loan term, and annual interest rate into our mortgage calculator, you’ll see that the amount you pay the lender each month is $14,322.46. As we said before, $10,000 of your first payment goes to cover the interest cost, which means the remaining $4,322.46 is used to pay down your outstanding principal.
How Does “Amortization” Work?
You might be wondering why your monthly mortgage payment remains the same (assuming it’s a fixed-rate loan). Intuitively, as we continue to make payments, the principal balance decreases, so the amount paid should also decrease. Why doesn’t our monthly bill get smaller?
This is not the case because lenders use “Amortization” to calculate your payments, so you pay the same amount each month. Initially, most of your monthly payment goes toward interest, with a smaller portion going toward the principal.
Returning to our previous example: assuming you do not refinance, your monthly payment will remain the same after 15 years. But by now, your principal balance has been significantly reduced. After 15 years, your loan principal balance will be approximately $1,936,284.
Multiplying $1,936,284 by the interest rate (0.04 ÷ 12 months), the interest portion of the payment is now only $6,480.42. However, you are paying off a larger portion of the principal, meaning that $7,842.04 of the monthly $14,322.46 payment will go toward the principal.
The table below shows the monthly payments at different points in a 30-year mortgage. You should notice that over the life of the loan, the interest portion of the monthly payment decreases while the principal portion increases.
| Year | Principal | Interest | Monthly Payment |
| Year 1 | $4,322.46 | $10,000 | $14,322.46 |
| Year 15 | $7,842.04 | $6,480.42 | $14,322.46 |
| Year 20 | $9,575.11 | $4,747.35 | $14,322.46 |
| Year 30 | $14,274.11 | $49.17 | $14,322.46 |
In the final year of your mortgage, you will be paying off mostly principal and a small amount of interest. This averaging makes your payments clearer and more manageable.
Adjustable-Rate Mortgages
If you take out a fixed-rate mortgage, your monthly payment will remain the same for the duration of the loan. As more of your payment is allocated to the principal, the portion of your payment that goes toward interest will gradually decrease.
However, the reality is not always this simple. Often, borrowers are switched to an adjustable-rate mortgage after their fixed-rate period ends. With the current trend of rising interest rates, this rate will be higher. Suddenly, you will find that your monthly payment has changed. This is because your outstanding principal is being multiplied by a different (usually higher) interest rate.
If you have any questions or needs regarding adjustable-rate mortgages, please feel free to consult us. We are official partners with the three major local banks and seven foreign banks. Contact us now to get the lowest interest rates.
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