When you’re taking out a mortgage or home loan, it’s important to understand that you’re paying for both the amount borrowed and the percentage rate on top of it. So the question of how to calculate interest on home loan is essential in your decision-making on whether an additional mortgage tap is worthwhile!
Mortgages come with different terms, but in most cases, you’ll be responsible for both paying off your balance and covering the percentage rate. This fee is charged as a percentage of what’s left once that total has been paid back. It can help reduce how much money goes out whilst still leaving some available should new loans need to be taken out!
It can be a bit daunting to grasp exactly how to calculate interest on home loan. A home loan calculator might come in handy when identifying your debt amount and what percentage will go towards the principal and the percentage. It’s still a wise idea to have a good understanding of what is the formula for calculating interest on a home loan.
Let us first circle back to the basics: What is interest?
Basically, interest is a fee you pay for utilising someone else’s (usually the bank’s or some other financial institution’s) money. When you get a mortgage, you’ll see that it comes with an annual percentage rate. Calculate the percentage for each monthly instalment by multiplying the balance of the loan by the interest rate.
If you take out a $100,000 mortgage, your principal will begin at $100,000. If your mortgage has a 5 per cent interest rate, you’ll pay $5 cents for every $100 owed each year. Your balance normally lowers over the course of the year due to repayments so you won’t constantly be paying the $5 cents for every $100. This is because the return is typically calculated monthly based on the remaining balance.
Here are some factors that can affect the amount of your home loan interest
- Home loan interest rate. This is simply the rate that the bank charges you on the mortgage, say 3% per year. Some banks present lower percentage rates over a limited time, after which it will revert to the usual rate.
- RBA cash rate. The official cash rate set by the Reserve Bank of Australia every first Tuesday of the month (except January). This will determine the interest rate on your loan. The rates the lenders would charge depend on the official borrowing cost.
- Loan Amount. When you borrow a larger amount, the higher the percentage rate you will need to pay off. Some banks may offer a discount on these rates for larger amounts borrowed.
- Number of days in the month. Oftentimes, lenders charge you with a monthly percentage on a home loan calculated on a daily basis. You could pay a smaller interest amount in February that only has 28 days as compared to March with 31 days.
- Loan term. The time it will take to pay off a loan also affects the amount of interest to be paid. A shorter term can mean fewer return repayments.
- Payment frequency. Most lenders will let you choose your preferred instalment frequency. This could be weekly, fortnightly or on monthly basis. The return rate you pay will vary based on the repayment plan you choose. You can expect to pay less interest on your mortgage if you make payments more frequently.
How is interest calculated on a home loan?
To know how much return you need to pay each month, you need to distinguish the following:
- Principal amount
- Interest rate
- Monthly payment amount
Whilst a personal loan repayment calculator is available, you can also try this formula for calculating interest on a home loan.
First, you take the interest rate and convert it into a decimal by dividing it by 100. For example, a 5 per cent annual percentage rate (APR) becomes 0.05. Since this amount is for a full year, you’d want to find out the rate per month. Simply divide the amount by 12, since there are 12 months in a year. In this hypothetical situation, you should get 0.0041667, which is the decimal monthly rate.
Now multiply this monthly rate to the principal amount. The first month’s interest on a $100,000 loan would be $416.67. Let’s say that the monthly repayment is $580. In the first month, $416.67 would be spent on interest, leaving $163.33 for principal repayment ($580 less $416.67).
After Month 1, your outstanding principal balance is now at $99,836.67 ($100,000 minus $163.33), which you then use to compute the interest for the next month. ($99,836.70 x 0.0041667 = $415.990 in interest, leaving a $164.01 principal payment.)
As you can see in this example, the amount you pay in interest decreases from one month to the next. You may use these calculations to figure out how much interest you’ll pay over the life of the mortgage. Still, you might also want to see how changing your payment amount or making additional payments throughout the year affects your expenditures.
Discover the home loan interest calculator
Knowing how to calculate interest on home loan can help you plan out your budget so you can avoid unforeseen costs that could negatively impact your finances.
With BFG’s commitment to making the home loan process more uncomplicated, we’ve built a home loan mortgage calculator that will do the math for you. You just have to plug in the numbers and wait for your result.
Along with our promise of an effortless home buying journey is a guarantee that we do the hard work to get you the best home loan for your goals. If for any reason, you aren’t satisfied with the outcome, we will refund 50% of our commission and work with you in making things right. Book your free consultation with our mortgage experts whenever you’re ready!