How Mortgage Interest is Paid and Calculated

Home mortgage interest is any interest that is paid on a mortgage loan secured by a home.  The mortgage loan can be for the purchase of a new home, a mortgage that has been refinanced or a second mortgage.  On all of these home loans the repayment period will include monthly mortgage payments of principal and interest, unless the home loan has an interest only feature in which case the home loan will not include the repayment of principal.  In the terms for the monthly mortgage payment on the home loans the mortgage interest that is paid with each total monthly mortgage payment is paid in arrears.  This means that the principal and interest payment will pay for the 30 day period of mortgage interest before the payment due date.  A home mortgage loan payment paid on the 1st of April is paying for the mortgage interest that accrued in March. 

Every time someone closes on a home loan they will prepay the mortgage interest from the time the money is disbursed to the beginning of the next month.  Then the first regular monthly mortgage payment is due on the following month.  For example, you may have a March 15 closing on a home loan, and the mortgage loan agreement calls for the monthly payment to occur on the first of the month.  At the closing you will be required to pay the mortgage interest for the remainder of the month of March at the loan closing, approximately half the month.  However, your next payment is not due on April 1, but rather will be due May 1.  The payment for April which is due on May 1 and all subsequent payments are made “in arrears” or for use of the money for the previous month.

When you engage in a mortgage refinance and see the payoff letter from your existing mortgage, you will notice it is higher than the principal balance.  Since the payments are paying the interest in arrears, if you paid a June 1st payment and request to see a payoff for June, the payoff will have the interest due from June 1st to whatever day of that month you want the payoff good for.  Each scheduled mortgage payment on a fully amortizing loan is divided between the interest due for the month and the principal amortization, which is the gradual reduction in the original mortgage loan balance. 

It is easy to compute your unpaid principal mortgage loan balance after you make your first monthly mortgage payment.  Let’s use a home loan of $200,000 with an interest rate of 6%.  First, take your principal mortgage loan balance of $200,000 and multiply it times your 6% annual interest rate.  The annual interest amount is $12,000.  Divide the annual interest figure by 12 months to arrive at the monthly interest due.  That number is $1000.

Since your fully amortizing payment on this home loan would be $1199.10, to figure the principal portion of that payment, you would subtract the monthly interest number ($1000) from the principal and interest payment ($1199.10).  The result is $199.10, which is the principal portion of your monthly mortgage payment.

Now, subtract the $199.10 principal portion paid from the unpaid principal balance of $200,000.  That number is $199800.90, which is the remaining unpaid principal balance.  The next month’s monthly mortgage payment will have the same mortgage rate but the amount of interest paid on the loan will be slightly less because the principal balance of the loan is less.  Therefore, the next monthly mortgage payment has a larger portion of the payment applied to principal and a smaller portion to interest.  In the beginning period of the home loan, these numbers will seem inconsequential but as the numbers of monthly mortgage payments add up, the amount going to interest decreases as the mortgage loan balance decreases. 

With each consecutive payment, your unpaid principal balance will drop by a slightly higher principal reduction amount over the previous month.  This is because although the unpaid balance is computed using the same method every month, your principal portion of the monthly payment will increase while the interest portion will get smaller.

Note, these numbers are round numbers for purposes of simplicity of understanding.  If you are paying off a mortgage loan, you must add daily interest to the unpaid mortgage loan balance until the day the mortgage lender receives the payoff amount.  To compute daily interest for a mortgage loan payoff, take the principal balance times the interest rate and divide by 12 months, which will give you the monthly interest.  Then divide the monthly interest by 30 days, which will equal the daily interest.

As an example you have $100,000 and you decide to pay off your mortgage on January 5th. You know you will owe $99,800 as of January 1.  But you will also owe 5 days of mortgage interest.  How much is that?
$99,800 x 6% = $5,988 ÷ by 12 months = $499 ÷ by 30 days = $16.63 x 5 days = $83.17 interest due for five days.

Figured precisely, you would send the lender $99,800.40 plus $83.17 interest for a total payment of $99,883.57.