How are mortgage repayments calculated? Home loan costs broken down
Mortgage repayments are calculated so that you chip away at the total cost of your home loan over time.
What makes up a mortgage repayment varies by the type of home loan you have, how often you make repayments, fees, how big your loan is, and your interest rate. But how, exactly, do lenders calculate your mortgage repayments?
How do mortgage repayments work?
Home loan repayments chip away at the total debt you took out at the start of your mortgage. ‘Amortisation’ is the process of breaking down your home loan principal into these individual payments for 20 to 30-year terms.
A principal and interest mortgage repayment typically includes these costs:
- Principal repayments
- Interest rate charges
- Fees.
An interest-only home loan, on the other hand, would not take into account repayments on your principal loan amount.
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Principal repayment
Your principal repayment is a chunk of the original loan amount you borrowed. If you initially borrowed $500,000 from a lender, then your principal is $500,000.
This money is divided by the number of months or fortnights in your home loan term. For example, a 25-year home loan will spread the principal out over 300 months, making 300 principal repayments.
Some home loans just charge interest-only repayments for the first few years. These loans don’t pay down any of your principal, so you don’t build any home equity, but they can reduce the size of your repayments for a while.
Interest repayments
Interest is calculated daily by your lender and added to your mortgage repayments.
At the end of every business day, your lender multiplies your loan’s interest rate by how much of your principal you have left to repay, then divides this amount by 365 days, or 366 if it’s a leap year.
A monthly mortgage repayment will usually include 30 to 31 days of interest.
The type of interest rate you have can also affect your mortgage repayments. Variable interest rates ‘vary’ over time, which changes the amount of interest you pay, while fixed interest rates stay the same for a short term, typically 1 to 5 years.
Home loan fees
Lastly, your lender may charge administrative fees. These fees cover the maintenance and account-keeping required for your mortgage. Fees can be ongoing or once-offs.
There is no such thing as a truly fee-free home loan, since third-party charges may apply. Always read the product disclosure statement and target market determination before applying for a home loan.
How to calculate mortgage repayments
To calculate mortgage repayments, the easiest way is to use a mortgage repayment calculator. It’s a good idea to use one of these when you compare home loans, as it can help you weigh up the costs of each option on your shortlist.
If you’d prefer to do it manually, there is also a formula for calculating mortgage repayments, which you can see below. Be warned, it takes a bit of maths.
What is the formula for calculating mortgage repayments?
To calculate monthly mortgage repayments, the formula is:
M = P x [r x (1+r)^n] ÷ [(1+r)^n – 1]
M: Monthly mortgage repayment amount
P: Principal (your total loan amount)
r: Monthly interest rate (your annual rate, divided by 12 months)
n: The total number of monthly payments (your loan term multiplied by 12 months)
Mortgage formula example
For example, if you had a $500,000 home loan at an interest rate of 6% p.a. over 25 years, you can calculate your monthly principal and interest repayments like this:
- Determine the principal (P). This is the total amount borrowed, or $500,000 in the example provided.
- Convert the annual interest rate (r) to a monthly rate. In our case, divide 6% by 12, as there are 12 months in a year. This gives us a monthly rate of 0.005%.
- Determine the number of repayments (n) you will make over the loan term. As the loan term is 25 years, multiply 25 by 12 to get 300.
- Place these values into the formula, like so:
So, we know our principal (P) is $500,000, our monthly interest rate (r) is 0.005%, and the total number of repayments we’ll make (n) is 300. With this information, our formula now looks like this:
M = 500,000 x [0.005 x (1+0.005)^300] ÷ [(1+0.005)^300 – 1]
Once we add the figures inside the (brackets) and multiply them by the power of n (300), our formula reads:
M = 500,000 x [0.005 x 4.465] ÷ [4.465 – 1]
Then we continue calculating the figures inside the [square brackets] to get:
M = 500,000 x (0.022325 ÷ 3.465)
Then:
M = 500,000 x 0.006443
M = $3,221.50
So, on a $500,000 home loan, where you’re charged 6% p.a. interest over 25 years, your initial monthly repayment will be approximately $3,221.50.
Do home loan repayments decrease over time?
As you pay off more of your home loan, chipping away at the principal amount, you will gradually see your mortgage repayments decrease. This is because mortgage interest is calculated using the outstanding loan amount.
While the size of your principal will remain consistent for all of your mortgage repayments, the amount of interest charged will fall.
How to get cheaper mortgage repayments
There are several strategies you can take to lower your mortgage repayments.
1. If you haven't applied for a home loan yet
The main way to reduce the size of your mortgage repayments is to reduce the size of your principal, which means looking for cheaper properties. This way, you don’t have to borrow a large home loan – or save as much for a home loan deposit.
The size of your home loan deposit can also impact your mortgage repayments. Deposits establish your loan-to-value ratio (LVR). The lower your LVR, the lower your interest rate.
Aim for a 20% deposit (or an 80% LVR) to access a lender’s most competitive interest rates.
2. If you already have a home loan
If you’re already servicing your mortgage, you can focus on reducing your interest rate to save costs.
Here are the key ways to lower your home loan interest rate:
- Paying down as much of your principal as possible with extra repayments.
- Filling up your offset account, if you have one.
- Calling your lender to negotiate a lower interest rate.
- Refinancing your home loan.
Note if you want to refinance, you’ll need to establish your home equity by doing a property valuation. If your LVR has lowered either because your home value has risen or you’ve repaid more of your home loan, you may be eligible for a lower LVR tier and thus, a lower interest rate.
Additionally, when comparing home loans, pay attention to the fees charged with a mortgage account. While they don’t make up most of your home loan, a $20 monthly fee still adds up to $240 per year.
FAQs
What percentage of your income should mortgage repayments be?
It’s generally believed that your mortgage repayments should not be more than 30% of your monthly pre-tax income. This is also known as the threshold for what the Australian government calls, mortgage stress.
Are mortgage repayments tax deductible?
If you’re a property investor, you can claim the interest portion of your home loan repayments as a tax deduction. You cannot claim the principal. Other rental property expenses, such as agent fees, may be tax deductible.
Always consult a tax advisor when lodging your tax return.
Calculators
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Home loan rate change calculator
Home loan borrowing calculator
Mortgage repayment calculator
Stamp duty calculator
Budget calculator
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* WARNING: This comparison rate applies only to the example or examples given. Different amounts and terms will result in different comparison rates. Costs such as redraw fees or early repayment fees, and cost savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan. The comparison rate displayed is for a secured loan with monthly principal and interest repayments for $150,000 over 25 years.
** Initial monthly repayment figures are estimates only, based on the advertised rate. You can change the loan amount and term in the input boxes at the top of this table. Rates, fees and charges and therefore the total cost of the loan may vary depending on your loan amount, loan term, and credit history. Actual repayments will depend on your individual circumstances and interest rate changes.
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