How is interest calculated and paid off in a 30 year fixed rate mortgage loan?

Question

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

Answer 1

It’s a rate of 8% per annum, calculated on whatever the outstanding loan balance is, but that balance changes over time. When you close the loan balance is $500K, but part of your first payment is applied to principal, which decreases the outstanding balance slightly. This is called amortization. Home loans generally use “mortgage style” amortization, in which a formula is used to determine a level/fixed monthly payment (which has both a principal and interest component) that will result in the full amortization of the initial loan balance over the 30 year term.