> For the complete documentation index, see [llms.txt](https://guide.mypayoffpro.com/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://guide.mypayoffpro.com/how-mortgages-really-work/mortgage-interest-explained.md). # How mortgage interest works Mortgage interest is charged on the balance you still owe, recalculated every period. Your lender takes your outstanding balance, multiplies it by your annual rate divided by 12 (or by 365, depending on the accrual method), and that is the interest portion of your next payment. Everything left over reduces the balance. Because the balance starts high, the early interest charges are high too. That one mechanic is why a 30-year loan barely moves in its first few years. ## How is mortgage interest calculated? The standard formula for a monthly-accruing mortgage is: ``` Interest for the month = Current balance × (Annual rate ÷ 12) ``` Take a $378,000 loan at 6.5% on a 30-year term. * Monthly rate: 6.5% ÷ 12 = 0.0054166... * Month 1 interest: $378,000 × 0.0054166... = **$2,047.50** The fully amortizing payment on that loan is **$2,389.22** per month. So in month one: | Item | Amount | | ----------- | ----------- | | Payment | $2,389.22 | | Interest | $2,047.50 | | Principal | $341.72 | | New balance | $377,658.28 | Month two starts from the smaller balance, so the interest is smaller: * $377,658.28 × 0.0054166... = **$2,045.65** * Principal that month: $343.57 That is the whole engine. The interest shrinks a little each month, the principal grows a little each month, and the payment stays the same. If you want to run this on your own numbers rather than mine, the [free payoff calculator](https://www.mypayoffpro.com/calculator) does the same arithmetic with your balance, rate and term. ## Is mortgage interest calculated daily or monthly? Both conventions exist, and which one you have is set by your note, not by a universal rule. * **Monthly accrual (most common on US fixed-rate mortgages).** Interest is computed once per period using rate ÷ 12. The number of days in the month does not change the charge. February and March cost the same. * **Daily accrual (simple daily interest).** Interest is computed each day on the balance outstanding that day, then summed for the billing period. A 31-day month costs more than a 30-day month. This matters in one practical way. On a daily-accrual loan, paying a few days early genuinely reduces the interest charged that period. On a standard monthly-accrual loan, paying early inside the same period usually does not change that month's interest at all, though it can change the date your extra principal starts working. Check your note or ask your servicer which method applies to your loan before you build a strategy around timing. ## How do you calculate daily interest on a mortgage? Divide the annual rate by the number of days in the year your lender uses, then multiply by the balance. On the same $378,000 at 6.5%: **Actual/365 method** ``` $378,000 × 0.065 ÷ 365 = $67.32 per day ``` * A 30-day month: $67.32 × 30 = $2,019.60 * A 31-day month: $67.32 × 31 = $2,086.92 **30/360 method** ``` $378,000 × 0.065 ÷ 360 = $68.25 per day ``` * Every month is treated as 30 days: $68.25 × 30 = $2,047.50 Notice that the 30/360 result is identical to the monthly calculation above. That is not a coincidence. Dividing by 12 and using 30-day months over a 360-day year are the same arithmetic expressed two ways. The actual/365 method is the one that makes month length matter. Put the daily figure another way: at a $378,000 balance this loan costs about $67 a day to carry. That daily cost falls as the balance falls, which is why the same extra payment buys you more in year 2 than in year 25. ## What percent of your mortgage payment is interest? At the start, most of it. On the $378,000 example: | Payment number | Interest portion | Percent of payment | | -------------- | ---------------- | ------------------ | | 1 | $2,047.50 | 85.7% | | 12 | $2,026.58 | 84.8% | | 60 (year 5) | $1,919.23 | 80.3% | | 120 (year 10) | $1,739.31 | 72.8% | | 180 (year 15) | $1,490.51 | 62.4% | | 240 (year 20) | $1,146.47 | 48.0% | | 300 (year 25) | $670.72 | 28.1% | | 360 | $12.85 | 0.5% | Over the first twelve payments you would pay $24,445.61 in interest and $4,225.03 in principal. After a full year of payments the balance has fallen from $378,000 to $373,774.97. That is what 6.5% charged on $378,000 produces before the balance has had time to move. ## Why is mortgage interest front loaded? Because the balance is largest at the beginning, not because the lender applies a special rule to the early years. Your payment is fixed. Interest is a percentage of a shrinking balance. So the interest slice starts large and the principal slice gets whatever is left. Early on that leftover is small, which means the balance falls slowly, which means the next month's interest is still large. The cycle only breaks once the balance has come down enough for the arithmetic to tip. This is also why extra principal is worth so much more in year 2 than in year 25. A dollar of extra principal today removes that dollar's interest for every remaining month of the loan. ## Is mortgage interest compounded? On a standard amortizing mortgage that is paid as scheduled, no. Interest is charged each period and paid off in full by that period's payment, so there is nothing left over to earn interest on itself. That is simple interest, calculated periodically. Compounding only enters the picture when unpaid interest gets added to the balance. That happens with negative amortization, with some forbearance and deferral arrangements, and with certain adjustable products where the payment can be less than the accrued interest. If interest is ever capitalized onto your principal, it starts accruing interest of its own. What people usually mean when they say a mortgage "compounds" is the effect described above: interest charged on a large balance for a long time. The total gets very big, but the mechanism is repetition, not compounding. ## How do you calculate mortgage interest over 30 years? You cannot do it in one multiplication, because the balance changes every month. You have to run the schedule out. For the $378,000 loan at 6.5% over 360 months: * Total payments: about $860,116 * Total principal: $378,000 * **Total interest: $482,115.92** That is $1.28 of interest for every $1.00 borrowed. The final payment is slightly smaller than the rest because the last bit of principal rounds off. For a rough sanity check without building a table, multiply the monthly payment by the number of payments and subtract the original loan amount. That gives you total interest for a loan carried to term. The picture changes fast with extra principal. Adding $200 a month to the same loan pays it off in 24 years 2 months instead of 30 years, and total interest drops to about $371,806. That is roughly $110,000 less interest and just under six years off the term. You can test your own version of that on the [payoff calculator](https://www.mypayoffpro.com/calculator), or track it month by month with [PayOff Pro on the App Store](https://apps.apple.com/app/payoff-pro/id6752794539). ## How do banks calculate mortgage interest? Servicers follow the note. In practice that means: 1. They read the accrual method from your loan documents: monthly (rate ÷ 12) or daily (rate ÷ 365 or ÷ 360). 2. They apply it to the balance as of the accrual date, not to the original loan amount. 3. They apply your payment in a set order, typically fees first, then accrued interest, then principal, then escrow. That ordering is why an extra payment which is not labelled correctly can end up sitting in escrow or in a suspense account instead of reducing your balance. 4. They may hold a partial payment until a full payment amount accumulates. So if you send extra money, say explicitly that it is a principal-only payment. Then check your next statement and confirm the balance moved by the amount you expected. That is the check that catches a misapplied payment while it is still easy to correct. ## Where to go next * [Mortgage amortization explained](/how-mortgages-really-work/amortization-explained.md) covers the schedule itself: how the split between principal and interest is set for all 360 months, and when principal finally overtakes interest. * More worked examples and strategy write-ups live on the [PayOff Pro blog](https://www.mypayoffpro.com/blog). A note on accuracy: the figures above are computed for a $378,000 loan at 6.5% on a 30-year fixed term, with no escrow, fees or insurance included. Your own numbers will differ, rounding conventions vary between servicers, and accrual method is set by your note. Use your statement and your loan documents as the authority. --- # Agent Instructions This documentation is published with GitBook. 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