How is principal and interest calculated on a home loan

When you are ready to buy your new home, you may have decided that mortgage lending is the right choice to finance your purchase. If this is the case, you aren't alone. Countless Americans rely on mortgage lending every year to help them take the next step on their life's path and become homeowners. Mortgage lenders provide future homeowners with an absolutely indispensable system of support on which they can move forward with the rest of their lives. That being said, these loans are a significant responsibility. Failure to meet the terms of your mortgage could result in a series of very unfortunate consequences, including foreclosure on your property. With that in mind, it is essential that you take the time to understand how your monthly payments are structured and how you will pay back your loan over time.

Mortgage Types 

Fixed and variable interest rate mortgages are the most most common forms of home loans used by property buyers today. The difference between them is relatively straightforward: in a fixed-rate mortgage, the interest rate assigned to you by the bank at the commencement of your borrowing remains the same throughout the life of the loan. In a variable interest rate mortgage, however, the interest rate assigned to you will change at periodic intervals throughout the duration of the loan. Your lender will disclose all of the information related to your interest rate before you agree to borrow the funds, including a schedule of adjustments on your interest in a variable rate mortgage.

Calculating Principal and Interest

Once you have determined the logistics of your mortgage, including the duration of your repayment, the amount borrowed and your interest rate, your bank will disclose what your monthly payment will be. This figure will take into account both your mortgage principal and the interest accruing on the principal. In the early stages of your mortgage, you should plan on paying back much more interest than principal. The reason for this can be explained as follows. If, for example, you have taken out a $417,000 mortgage to pay for your property in the Bay Area at a 5 percent interest rate, your monthly payments will be $2,239. In order to determine what proportion of this payment is interest and principal, do the following.

First, convert your annual interest rate from a percentage into a decimal format by diving the figure by 100. So, 5/ 100 = 0.05. Next, divide this number by 12 to compute your monthly interest rate. Following this formula, your monthly interest will be 0.00416. Now, multiple this number by the total principal (interest is always calculated on your principal, not your monthly payment): $417,000 * 0.00416 = $1,734.72.

Therefore, $1,734.72 of your first months payment will be interest. Subtract this figure from your monthly payment to determine what amount of your payment is reducing your principal balance: $2,239 - $1,734.72 = $504.28.

You can use this formula on a monthly basis by reducing the principal balance by the amount of total principal you have already paid.

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