How Mortgage Interest Is Calculated, with an Example

A fixed-rate mortgage has the same payment every month, which hides what is happening inside it. The share that goes to interest is large at first and shrinks over time. Understanding why helps you see the value of extra payments and the cost of long loans.

The monthly calculation

Each month, your lender calculates interest on the balance you still owe:

Interest for the month = balance × (annual rate ÷ 12)

The rest of your payment reduces the balance. Next month, the balance is a little smaller, so the interest is a little smaller, and slightly more of the same payment goes to principal. This process is called amortization.

A $400,000 example

On a 30-year loan at 6.5%, the payment of principal and interest is $2,528.27.

• First month’s interest: $400,000 × 6.5% ÷ 12 = $2,166.67
• Principal that month: $2,528.27 − $2,166.67 = $361.60

So about 86% of the first payment is interest. Over the first full year you pay roughly $25,868 in interest and reduce the balance by only about $4,471, even though you send more than $30,000 to the lender.

The balance of a loan falls slowly early on and faster later, because the principal portion grows each month. This is why building equity feels slow in the first years of a 30-year loan.

The payment formula

The fixed payment comes from this formula:

M = P × [r(1 + r)^n] ÷ [(1 + r)^n − 1]

where P is the loan amount, r is the monthly interest rate (the annual rate divided by 12), and n is the number of monthly payments. It is the payment that brings the balance to exactly zero after n payments. At a 0% rate the payment is simply P ÷ n.

Why extra payments are so effective

Interest is charged on the current balance, so any principal you pay early eliminates the interest it would have generated for the rest of the loan. An extra $200 a month early in a 30-year loan can remove many years and tens of thousands of dollars of interest. The same extra payment late in the loan saves far less, because there is little interest left to avoid.

Try your own numbers with the amortization calculator, which shows the balance year by year and lets you download every month’s split, or use the extra payment calculator.

What changes the total interest

• The rate. A higher rate raises both the payment and total interest.
• The term. Longer loans have lower payments but much more total interest. See 15-year vs 30-year.
• Extra principal payments. Each one shortens the loan and cuts interest.
• Refinancing. A new loan resets the schedule, which is why a lower rate does not always reduce total interest. See should you refinance.

Check how your lender applies payments

Ask your servicer to apply extra money to principal, not to future payments, and confirm there is no prepayment penalty. Most mortgages today have none, but it is worth checking.

Common questions

Is mortgage interest calculated daily or monthly?

Most U.S. fixed-rate mortgages calculate interest monthly on the balance outstanding, using the annual rate divided by twelve, as in the examples here. Some loans, such as certain servicing arrangements and the interest due at closing, use daily interest. The difference to your payment is small, but check your note.

Why does my balance barely move in the first years?

Because interest is charged on a large balance, most of each early payment is interest. The principal portion grows every month, so the balance falls faster later in the loan. The amortization calculator shows the year-by-year balance for your numbers.

Does paying biweekly help?

Paying half the monthly payment every two weeks results in 26 half payments, equal to 13 full payments a year, so you pay one extra payment annually. That extra principal shortens the loan. You can get the same effect by adding one-twelfth of a payment to each monthly payment. Make sure your servicer applies the extra to principal and does not charge a fee for the arrangement.

Key takeaways

• Each month’s interest is the balance times the monthly rate.
• Early payments are mostly interest, so early extra principal saves the most.
• The term and the rate drive total interest more than anything else.