How Mortgage & Loan Interest is Calculated: Complete Amortization Guide

1. The Formula Behind a Level Monthly Payment

A fixed-rate loan is priced as an annuity: the lender solves for the one payment that clears the balance on the last scheduled date, with interest charged on whatever is still outstanding each month.

M = P × [ r(1 + r)ⁿ ] / [ (1 + r)ⁿ – 1 ]

• M = the payment that stays identical for the whole term
• P = amount financed, which is the price less your down payment
• r = annual rate divided by 12, so 6.5% becomes 0.0054167
• n = number of payments, so 30 years becomes 360

Worked through on $400,000 borrowed at 6.5 percent for 30 years, that is a payment of $2,528.27. Multiplied out, 360 payments come to $910,177.95, and the $510,177.95 above the amount borrowed is the cost of the time. Run the same money through a mortgage preset — a $350,000 price with $70,000 down at 6.8 percent — and the financed $280,000 pays $1,825.39 a month and $377,140.59 in interest.

2. What Each Payment Is Actually Doing

The payment never changes; the split inside it changes every single month. Interest is charged on the balance you still owe, so while the balance is large the interest slice is large too, and only the remainder touches principal. Here is that split at eight points in the 30-year example:

Monthly amortization schedule for a $400,000 loan at 6.5 percent over 30 years, showing payment, interest, principal and remaining balance at selected months

Read down the last column and the shape of the loan becomes obvious: 85.7 percent of the first payment is interest, and the balance has fallen only $361.61. Month 240 is where the handover happens — the crossover lands at month 233, part-way through year 20 — and by the final payment interest is down to $13.62 while $2,514.65 retires the last of the debt. The curve is shallow for years and then steep, which is why an extra payment early is worth so much more than the same money paid late.

3. Nominal Rate, Effective Rate, and the Number on Your Quote

Dividing the annual rate by twelve is the convention lenders use, and it is also the reason a 6.5 percent mortgage costs you a little more than 6.5 percent of the balance in a year: every month's interest is charged again for the eleven months that follow it. Compounded that way, 6.5 percent nominal works out to 6.70 percent effective, and 6.8 percent becomes 7.02 percent. When you compare a mortgage against a savings account, a bond, or an assumed investment return, use the effective figure or you are comparing two different things.

The other number worth understanding is APR. The note rate prices the money; APR folds in the charges the lender wraps into the deal, which is why two quotes with the same note rate can carry different APRs. Compare offers on APR, then decide separately whether paying those charges up front or accepting a higher rate suits how long you will stay.

4. Four Ways to Pay the Lender Less

Each row below is the same $400,000 loan at 6.5 percent, re-run through the month-by-month loop with a different amount hitting principal. The term and the interest column are results, not assumptions.

Comparison of interest paid and term length for five repayment strategies on a $400,000 loan at 6.5 percent

Two things in that table are easy to miss. First, $200 a month and one extra annual payment cost you roughly the same per year and save roughly the same — about $111,900 — so choose whichever cadence fits your cash flow rather than whichever sounds more disciplined. Second, the bi-weekly row is not the same method restated: this calculator halves the payment and charges the annual rate divided by 26 across 26 periods a year, which is a slightly different loan from a monthly schedule with a 13th payment. If your servicer offers bi-weekly, ask which model their amortization uses before you compare their savings figure with anyone else's.

5. Reading a Schedule Instead of Memorising One

The calculator here runs terms from 1 to 40 years, clamps the amortization at 480 months, and lists the first twelve rows on screen until you ask for the whole schedule. Exporting to CSV writes every month with the columns Month, Payment, Principal, Interest and Balance, and your extra payment is already folded into the principal and balance columns, which makes it the file to hand to an accountant rather than a screenshot.

• Check the last balance, not the last payment. A schedule that ends at a non-zero balance is telling you the payment assumption is wrong.
• Look at month 12 first. If principal has barely moved, the term is long, the rate is high, or both.
• Re-run with a flat extra before you commit to it. The savings column changes with the rate, so the figure you read on page 4 of this guide is specific to 6.5 percent.

6. Where This Arithmetic Stops Helping

• Escrow. The formula prices principal and interest only. Property tax, insurance and mortgage insurance while your equity is under twenty percent sit on top of the payment in most statements.
• Adjustable rates. A level payment assumes one rate for one term. An ARM breaks that assumption at its first adjustment, so a schedule built on the introductory rate describes a loan that no longer exists.
• Prepayment terms. Extra payments only save money if the lender applies them to principal and does not charge for the privilege. Check the note before assuming your bonus reaches the balance.
• Points and fees. This page compares interest across repayment strategies; it does not model the cost of buying a rate down, which is a break-even calculation against your own planned length of stay.
• Rounding. Lenders round to the cent and to whole months in places this loop does not, so expect a difference of a few dollars across 360 payments rather than an exact match to your statement.

This is mathematics, not advice. The figures come from the formulas above applied to an example balance. Rates, fees and tax treatment depend on your offer and your jurisdiction, so confirm anything material with your lender and, for tax questions, a qualified adviser.