My monthly mortgage payment is GBP965. Of that, monthly interest varies from GBP714 to GBP770. The annual interest rate 5.64% and the remaining term is just under 27 years, five years fixed.
Clearly the interest is currently much more than 5.64%. What’s the calculation here?
In: Other
Because you plan to make mortgage payments for a long time. If you make larger payments, your mortgage will be paid off sooner. Much less, and it would take forever to pay off the mortgage.
In order to make all payments the same, they start off mostly interest. As the balance goes down (which is very slowly at first) they are more principal. In the last 5 years, the balance is low enough that most of them is principal.
It’s 5.64% of the remaining balance on your mortgage. I’m estimating that you have about GBP 160,000 left on your mortage. Is that right? So every year, the interest payment is 5.64% of ~GBP 160,000, which means every month the interest payment is 5.64% / 12 of GBP ~160,000.
How do you figure that the interest is “much more than 5.64%”?
Interest is calculated based on how much you owe on the loan, which is usually a very large number. 5.64% of a very large number is still a lot of money.
Lets Ignore all the nuances of exactly how the interest and your rate are calculated and do some ‘back of the envelope’ style math. What was your remaining principle like? 160,000-ish?
5.64% of 160,000 is about 9000. That’s about how much interest your loan accumulates every year. divide that by 12 months gets you 750 in interest every month.
Each month your interest is 5.64% on the remaining balance of your mortgage. It will decrease as you pat down the principal over time.
The amount you pay in interest isn’t *quite* as simple as simply multiplying the remaining principal by the interest rate. There’s more steps to it because loans will have both an annual percentage rate (APR) and a compound rate. The compound rate is the APR divided by how often that fractional interest rate compounds with the year, and you have to consider *both*.
For example, let’s say we have two $100,000 loans each with an APR of 12%. One has a yearly compound rate, and one has a a monthly compound rate. So what we’re looking for here is a different APY, or annual percentage *yield*.
The formula for APY, when R is the APR and N is the number of times interest compounds in a year is APY = (1+r/n)^n – 1. Now we don’t have to worry about this math too much other than to realize as N gets bigger the APY gets bigger.
High level math, a $100,000 loan with a 12% APR and a 1 year compound period will, after 1 year, rise to $112,000.
But for a monthly compound period that figure is $112,682. The mere fact that interest is compounding monthly, instead of yearly *even though both initial loan amounts and both annual percentage rates are identical* makes a difference of $682.
As for why your rate varies month to month, I”m guessing the compound rate is “daily” (meaning *each and every day* the loan value increases by .0564/365 in interest) but you’re billed monthly, and some months have more days than others.
EDIT: that explains why your interest changes month to month but not why the payment stays the same. Put simply, banks already factor this in. They know the loan duration. They know the interest rate. They know how often that rate compounds, they know how often you make payments. Banks use a process called “amortization” to figure out *exactly* what your monthly payment should be, each and every month so that you pay it off exactly on time. That’s why fluctuations in how much you pay in interest every month don’t change your monthly payment. Your monthly payment has been calculated to factor all this in.
This used to be a manual process back in the day, there’s a whole set of complex formulas that go into it. Now there’s computer programs where you just plug in the various values and it instantly does the calculation.
Amortization! In order to keep your monthly payment the same, you have to pay more interest up front then slowly chip away at principal.
You could alternative payment schedules, both those are really inconvenient compared to how the average person receives their income
Let’s simplify to make it easy to understand.
Interest rates are 6%, and your Mortgage is $100. You make $24 / year, or $2 / month .
Interest is usually compounded monthly, which means you owe an additional 0.5% per month, or $0.50. You can only afford to pay 40% of your take-home pay on housing, so you pay $0.60, and have effectively paid 10 cents off your mortgage, and 50 cents in interest.
Just like that.
That said, when you have paid half of your mortgage off, you only owe $50, and interest is just $0.25 / month. You are still paying 60 cents, but now 35 cents is going to principal, and 25c interest. Your LAST payment will be almost all principal, obviously
Lets say your loan is GBP150,000. For a 5.64% interest rate, that means you have to pay GBP8460 interest in the first year. That means your monthly interest payment alone will be about GBP710-770/mo. The remaining amount of your payment goes into principal, which will slowly decrease the amount you owe over 27 years.
A slightly different angle:
The reason why your mortgage payment is mostly interest is because you pay the interest for the loan up front.
There’s a point, roughly halfway during the term of your loan where the principle and interest will be equal.
You’re paying the bank to have their money for the next 30 years.
This is why it’s so important to make extra payments especially during the first half of the loan.
You can shorten your term by 5-10 years, and drastically reduce the effective interest rate by giving them back their money early.
I wish this was taught in school.
This is the most helpful tool to understand your mortgage as well as how reducing term/making overpayments/changing rates will affect you.
https://www.drcalculator.com/mortgage/
Latest Answers