How is Mortgage Interest Calculated?

Prospective homebuyers are still contending with an expensive housing market. From soaring home prices to elevated mortgage rates, it can be a challenging climate for young families trying to purchase even a starter home or a small condominium.

For many households, the most significant issue is mortgage interest.

According to Freddie Mac’s Primary Mortgage Market Survey or the Mortgage Bankers Association weekly survey, the average 30-year fixed mortgage rate hovers around seven percent. With U.S. Treasury yields staying high even as the Federal Reserve cuts interest rates, borrowing instruments continue to be expensive.

However, while the mortgage rate can exacerbate housing costs, many households are determining how mortgage interest is calculated.

So, how is interest calculated on a mortgage? Let’s break it down.

How is Mortgage Interest Calculated?

First, mortgage interest is calculated in the United States using an amortization formula. This formula essentially divides your monthly payment between the principal and interest.

In the early years of your mortgage term, a larger share of your payment is dedicated toward the interest. As time goes by, a more significant amount of the payment is applied to the principal.

Put simply, mortgage lenders multiply borrowers’ outstanding balances by the annual interest rate and then divide by 12.

To go a bit deeper, let’s assume that you maintain a mortgage of $100,000 and your monthly interest rate is 0.333 percent. The initial month’s interest would be $100,000 multiplied by 0.003333, which equals $333. So, if your monthly payment is $500, you subtract $333, which means $166 is transferred to the principal.

It should be noted that many factors can influence how much interest you pay: the principal amount to borrow, credit score, repayment schedule, and loan term. The best strategies to obtain the most competitive mortgage interest rate are to bolster your credit score, reduce your debt-to-income ratio, select a shorter repayment period, and shop around.

“Before taking out a loan, it’s vital to calculate how much you’ll pay in interest to understand the true borrowing costs. Ask the lender if interest is assessed using the simple interest formula or an amortization schedule. Then, use the appropriate formula or an online calculator to run the numbers,” Bankrate writes.

Will Mortgage Rates Come Down?

Now that prospective homebuyers have determined how mortgage interest is calculated, will there be any relief on the way?

The Federal Reserve has hit the pause button in its rate-cutting cycle, and investors do not expect the next quarter-point reduction until June or July. This matters because the 30-year mortgage rate is benchmarked to the ten-year Treasury yield.

The financial markets are forward-looking, and the U.S. central bank has signaled that it will take it slow before bringing interest rates to a more neutral level. But why is the Fed driving below the speed limit? One word: Inflation.

Monetary policymakers have indicated upside inflation risks. Since the Fed followed through on a super-sized half-point cut in September, the three leading inflation gauges have risen every month. Early estimates suggest that the recent uptick in inflation might have reached its zenith.

Fed Chair Jerome Powell does not anticipate making a policy move until there is progress on the inflation front.

“We’re going to be focusing on seeing real progress on inflation or, alternatively, some weakness in the labor market before we—before we consider making adjustments,” Powell told reporters at the post-meeting January Federal Open Market Committee (FOMC) meeting.

Meanwhile, a new Reuters survey of economists suggests that the Fed will not make its next move until the next quarter, in line with the futures market.

Amid concerns that President Donald Trump’s tariffs will rekindle the inflation flame, there have been murmurs of rate hikes. For now, the consensus is that the Fed will likely keep interest rates higher for longer than pull the trigger on an interest rate increase.

“The tariffs are inflationary and could be quite negative for economic growth as well. That uncertainty just means the Fed is sort of left waiting and wanting to see what actually does happen,” said James Knightley, chief international economist at ING.

Feel the Interest

The mortgage market has drastically changed over the last few years. Years ago, when the Fed slashed rates to zero, homeowners took the bait and locked in their mortgages at historically low levels. This lifted demand, constrained supply, and created the golden handcuffs effect. Today, for those on the outside looking in, the path to homeownership appears bumpy, especially considering how much interest will be applied to a mortgage payment. With enough due diligence, research, and talks with banks and real estate agents, it will be doable.