How are interest and monthly payments calculated on a 30 year fixed rate mortgage loan?
Suppose there is a 30 year loan of 500,000 at 8% interest.
Would that 8% interest have to be paid each year for whatever amount is still left? Ex. 8% of 500,000 is 40,000, so the first year we would have to pay 40,000 in interest, then the next year about be 8% of whatever principal is left, so if 20,000 went to principal we have 480,000 left on the loan and 8% of that is 38,400 paid in interest only the second year.
Or is it calculated differently.
Thanks!
In: 208
Each month, you are charged 1/12 of the interest rate based on your remaining principal balance that month. So let’s take your example of a $500k loan with 8% interest.
In month 1, your interest will be equal to 1/12th of 8% (or 2/3 of 1%) times $500,000, or $3333.33. In addition to that interest, you will pay some amount of principal as well ($335.49, to be exact, making your remaining principal balance $499,664.51), for a total monthly payment of $3668.82.
In month 2, your interest will be equal to 1/12th of 8% times your new principal balance ($499,664.51), or $3331.10. But your monthly payment doesn’t change thanks to a fancy thing called amortization, so that means that that month’s payment will have $2.23 less going toward your interest and $2.23 more going toward your principal.
In month 3, your interest is $2.25 less than it was in month 2, so your principal is getting paid down a little faster still. And so on, and so forth.
So at the end of year 1, you’re actually paying a total of $39,849.05 in interest, not $40,000 which you might expect from an 8% interest rate on a $500k balance, because the interest that you’re charged goes down a tiny bit each month as your mortgage is paid down. Over time, the balance between principal and interest will start to shift significantly, so much so that in year 30 of your mortgage, you’re paying less than $2000 in interest despite the fact that your total monthly payment isn’t changing at all.
If you look at an [Amortization Calculator](https://www.calculator.net/amortization-calculator.html?cloanamount=500%2C000&cloanterm=30&cloantermmonth=0&cinterestrate=8&cstartmonth=10&cstartyear=2023&cexma=0&cexmsm=10&cexmsy=2023&cexya=0&cexysm=10&cexysy=2023&cexoa=0&cexosm=10&cexosy=2023&caot=0&xa1=0&xm1=10&xy1=2023&xa2=0&xm2=10&xy2=2023&xa3=0&xm3=10&xy3=2023&xa4=0&xm4=10&xy4=2023&xa5=0&xm5=10&xy5=2023&xa6=0&xm6=10&xy6=2023&xa7=0&xm7=10&xy7=2023&xa8=0&xm8=10&xy8=2023&xa9=0&xm9=10&xy9=2023&xa10=0&xm10=10&xy10=2023&printit=0&x=Calculate#calresult), you can see this effect in action. Look for the “Monthly Schedule” link above the table on the left to see a month by month breakdown. Amortization helps keep your monthly payments affordable in the early years of your mortgage, at the expense of not making much headway on paying down your principal until the late years of the mortgage.
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