How are interest rates calculated?


By Nicole Rueth - June 19, 2019

How are interest rates calculated?  I mean the most common liability is a mortgage; but if asked many people can't explain how a mortgage amortizes or calculates.  Let's demystify the mortgage loan shall we.

When you establish a new mortgage, the monthly payment is fixed for the fully amortized term of the loan.  i.e. if you have a 30 yr fixed loan, the interest is calculated day 1 and the payment is set so that the mortgage is paid off at the end of the term.  Now, if you have a mortgage at 4.5% fixed rate; you pay .375% (4.5%/12) of your loan amount every month.  In the beginning so much of your payment is interest because that .375% is multiplied by your remaining principle balance.  Since your payment is fixed, the small difference is the principle.   As you pay down the balance, that .375% is less, so more is allocated to the principle portion.  

If you make extra principle payments to your loan, you can shave off years from the back end of your loan term.  This happens because as you reduce your loan balance, the .375% interest becomes less, so more of each monthly mortgage payment continues to go towards principle.

You can also explore recasting to lower your monthly payment if you pay a lump sum towards your loan.  This will keep your term the same and interest higher.. so something to weigh out.

If you want the best rate and start building your wealth in real estate, give me a call today to get started.  
 
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