What is the mortgage interest payment formula and why does it yield different results every month on a fixed rate mortgage?
Answer:The interest payment formula for a month is:
Interest payment = Interest rate x loan balance at end of last month
To understand the different results through mortgage interest payment formula, you first need to know that the payments you make every month consist of two parts:
- The interest payment
- The amortization payment (amount by which your mortgage is reduced every month)
On fixed rate mortgages, your mortgage loan amount is lessening by a little bit every month and interest payment is calculated on the remaining balance.
This means that if the remaining balance changes every month, the interest payment would change every month automatically. You'll be able to better understand this with the help of a mortgage payment schedule.
Example of Calculation of Mortgage Interest Payment
Consider a fixed rate mortgage of $120,000 at 7.2% APR, payable in 15 years. To see how interest payment is affected every month by the lessening principal, we make a payment schedule of the first six months.
| Month | Principal | Monthly Payment | Interest Payment | Amortization |
|---|---|---|---|---|
| 0 | $120,000 | $0 | $0 | $0 |
| 1 | $119,628 | $1,092 | $720 | $372 |
| 2 | $119,034 | $1,092 | $498 | $594 |
| 3 | $118,438 | $1,092 | $496 | $596 |
| 4 | $117,840 | $1,092 | $493 | $599 |
| 5 | $117,239 | $1,092 | $491 | $601 |
| 6 | $116,635 | $1,092 | $488 | $604 |
You can see how amortization reduces the Principal balance every month. Then the next month, interest is calculated on that new, lessened principal balance and that is why interest payment changes every month.
If you've ever taken an interest only loan, you'd know that during the initial period all your monthly payments are used to cancel out the interest payment. There is no "amortization payment" in that period. That is why the Principal balance remains unchanged and so do the interest payments.
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