How Does Mortgage Interest Work?
Mortgage interest is the cost you pay to borrow money to buy a home. It’s calculated as a percentage of your loan balance and makes up a large portion of your monthly payment—especially in the early years of your mortgage. Over time, as you pay down what you owe, the amount of interest you pay each month gradually decreases.
In this Redfin article, we’ll break down mortgage interest in plain language, including:
- What mortgage interest is and where it shows up in your payment
- How principal, interest, and amortization work together
- Why early payments are interest-heavy
- How to read an amortization schedule to understand long-term costs
Mortgage interest basics: principal, interest, and amortization
When you make a mortgage payment, your money is split between two main components: principal and interest. How those amounts are divided each month is determined by amortization.
Think of it like this:
- Principal – The amount you borrowed to buy the home
- Interest – The fee the lender charges for lending you that money
- Amortization – The schedule that determines how your loan balance is paid down over time through fixed monthly payments
At the start of your loan, a larger share of your payment goes toward interest. As the principal balance shrinks, more of each payment goes toward paying down the loan itself.
Mini amortization example (30-year loan, fixed rate):
| Payment | Total Payment | Interest | Principal | Remaining Balance |
| 1 | $1,500 | $1,200 | $300 | $299,700 |
| 12 | $1,500 | $1,150 | $350 | $295,800 |
| 60 | $1,500 | $1,000 | $500 | $272,000 |
This gradual shift is the core of how mortgage interest works.
What mortgage interest is and how it shows up in your payment
Mortgage interest is essentially the price you pay for access to borrowed money. Lenders charge interest to offset risk and earn a return over the life of the loan.
In a typical monthly mortgage payment, interest appears alongside other housing costs:
Sample monthly payment breakdown:
- Principal: Pays down your loan balance
- Interest: Cost of borrowing the money
- Property taxes: Collected monthly and paid to your local government
- Homeowners insurance: Protects the home against damage
(These four parts are often referred to as PITI.)
While taxes and insurance may change over time, your interest portion follows a predictable pattern based on your loan balance and rate.
How amortization changes your interest vs. principal over time
Amortization explains why mortgage interest feels so expensive in the beginning. Since interest is calculated based on your remaining loan balance, a higher balance means higher interest charges.
Early years:
- Most of your payment goes toward interest
- Principal reduction is slow
- Loan balance decreases gradually
Later years:
- Interest charges drop as the balance shrinks
- More of each payment goes toward principal
- Equity builds faster
Mini schedule snapshot:
| Year | Interest Paid | Principal Paid |
| 1 | High | Low |
| 10 | Moderate | Moderate |
| 25 | Low | High |
This structure is normal and built into fixed-payment mortgages.
Understanding your amortization schedule
An amortization schedule is a table that shows exactly how each payment is applied over the life of your loan. It’s one of the best tools for understanding how much interest you’ll pay long-term.
What an amortization table shows:
- Payment number
- Total monthly payment
- Amount going to interest
- Amount going to principal
- Remaining loan balance
How to read it (step-by-step):
- Look at the first few rows to see how interest dominates early payments.
- Scan the middle years to see where principal and interest are closer to even.
- Review the final payments to understand how little interest remains near payoff.
Using an amortization schedule can also help you evaluate strategies like making extra payments or refinancing, since you can see how reducing the balance earlier affects total interest paid.
How mortgage interest is calculated
Mortgage interest is calculated based on three main factors: your remaining loan balance, your interest rate, and how often interest accrues. Each month, lenders apply your interest rate to the unpaid balance of your loan, then add that interest charge to your payment breakdown.
Here’s what influences how much interest you pay each month:
- Your current loan balance (higher balance = more interest)
- Your annual interest rate
- Whether interest accrues daily or monthly
- When your payment is applied during the month
Below, we’ll walk through the math step by step and show real-world examples.
Step-by-step formula for monthly mortgage interest
Most mortgages use a straightforward calculation to determine monthly interest.
Monthly interest formula (plain text):
Remaining loan balance × (annual interest rate ÷ 12)
Worked example: $200,000 loan at 4% interest
- Start with the loan balance: $200,000
- Convert the annual rate to a decimal: 4% = 0.04
- Divide the annual rate by 12 months: 0.04 ÷ 12 = 0.00333
- Multiply by the loan balance: $200,000 × 0.00333 = $666.67
Monthly interest charge: $666.67
If your total monthly payment is $1,200, then:
- $666.67 goes to interest
- The remaining $533.33 goes toward principal
As your balance decreases, this calculation produces a smaller interest charge each month.
Quick reference:
- Interest is calculated on the remaining balance, not the original loan amount
- The rate is divided by 12 for monthly payments
- Lower balances = lower interest over time
Is mortgage interest calculated daily or monthly?
This depends on the lender, but many mortgages accrue interest daily, even though you make payments monthly.
Daily vs. monthly interest accrual
| Accrual method | How it works | What it means for borrowers |
| Daily accrual | Interest builds each day based on the current balance | Paying earlier in the month can slightly reduce interest |
| Monthly accrual | Interest is calculated once per month | Payment timing matters less |
Key takeaways:
- Daily accrual is common and normal
- Making payments earlier can reduce total interest over time
- Extra or early payments usually go straight to principal, lowering future interest
This is why even small additional payments can make a noticeable difference over the life of a loan.
Examples: interest on $10,000, $300,000, and $500,000 loans
To see how loan size affects interest costs, here are examples using a 6% fixed rate.
| Loan amount | Term | Rate | Monthly payment* | Total interest paid |
| $10,000 | 30 years | 6% | ~$60 | ~$11,600 |
| $300,000 | 30 years | 6% | ~$1,799 | ~$347,600 |
| $500,000 | 30 years | 6% | ~$2,998 | ~$579,300 |
*Monthly payment includes principal and interest only.
What this shows:
- Larger loans dramatically increase total interest paid
- Even with the same rate, interest costs scale with balance and time
- Shorter loan terms reduce total interest, even with higher monthly payments
Understanding these mechanics helps explain why interest rate changes, extra payments, and loan term choices have such a big impact on the true cost of a mortgage.
How different mortgage types handle interest
Mortgage interest doesn’t work the same way across all loan types. The structure of your mortgage—whether the rate is fixed, adjustable, or temporarily interest-only—affects how predictable your payments are, how much interest you pay over time, and how much risk you take on.
Here’s a high-level comparison to set the stage:
| Loan type | How interest works | Payment stability | Interest risk |
| Fixed-rate mortgage | Rate stays the same for the full term | Very stable | Low |
| Adjustable-rate mortgage (ARM) | Rate changes after an initial fixed period | Variable | Medium to high |
| Interest-only mortgage | Payments cover interest only for a set time | Low early, higher later | High |
| Jumbo mortgage | Interest applies to larger, non-conforming loans | Depends on rate type | Varies |
How mortgage interest affects your monthly payment
Mortgage interest has a direct and lasting impact on what you pay each month. Even small changes in your interest rate can meaningfully change your monthly payment—and add up to tens or even hundreds of thousands of dollars over the life of a loan.
At a basic level:
- Higher interest rates = higher monthly payments
- Lower interest rates = lower monthly payments
- The impact grows with larger loan amounts and longer loan terms
Example: $300,000 loan, 30-year term
| Interest rate | Monthly payment (P&I) | Total interest paid |
| 5.0% | ~$1,610 | ~$279,600 |
| 6.0% | ~$1,799 | ~$347,600 |
| 7.0% | ~$1,996 | ~$418,500 |
A one-point increase from 6% to 7% raises the monthly payment by nearly $200—and adds more than $70,000 in total interest over 30 years.
Using mortgage calculators to estimate interest and payments
Mortgage calculators are one of the easiest ways to see how interest rates affect your payment before you apply for a loan. They let you adjust key variables and instantly see the results.
Real-world scenarios: $300,000 and $500,000 mortgages
To put interest into context, here’s how it affects common loan sizes using a 30-year fixed-rate mortgage at example rates.
| Loan amount | Rate | Term | Monthly payment (P&I) | Total interest |
| $300,000 | 6.0% | 30 years | ~$1,799 | ~$347,600 |
| $300,000 | 7.0% | 30 years | ~$1,996 | ~$418,500 |
| $500,000 | 6.0% | 30 years | ~$2,998 | ~$579,300 |
| $500,000 | 7.0% | 30 years | ~$3,327 | ~$697,700 |
What these scenarios show:
- Larger loans magnify the effect of interest rate changes
- Higher rates significantly increase lifetime borrowing costs
- Even modest rate differences can impact affordability
Understanding this relationship helps borrowers decide when to lock a rate, whether to consider a shorter term, and how much home they can realistically afford without stretching their budget.
Strategies to reduce how much mortgage interest you pay
Mortgage interest isn’t just about the rate you’re quoted—it’s also shaped by the choices you make before you apply and after you close. Some strategies help you qualify for a lower rate upfront, while others reduce how much interest accrues over time.
Think of it in two phases:
- Before you apply: Focus on qualifying for the best possible rate
- After you buy: Use payment and refinancing strategies to shrink long-term interest
Below are practical, lender-approved ways to reduce your total interest costs.
Improve your credit profile before you apply
Your credit profile plays a major role in determining your interest rate, and improvements made even a few months before applying can pay off.
Prioritized actions (with typical impact timelines):
- Pay down credit card balances (1–2 months): Lower utilization can quickly boost scores
- Make all payments on time (ongoing): Avoids negative marks that hurt rates
- Avoid opening new accounts (immediate): Prevents hard inquiries and score dips
- Correct credit report errors (30–60 days): Removing mistakes can raise scores meaningfully
Even a small score increase can unlock better pricing tiers and lower lifetime interest costs.
Increase your down payment or reduce loan amount
Putting more money down reduces how much you borrow—and less borrowed money means less interest paid over time.
Simple example: $400,000 home, 6% rate, 30-year term
| Down payment | Loan amount | Monthly payment (P&I) | Total interest |
| 5% ($20,000) | $380,000 | ~$2,278 | ~$440,000 |
| 20% ($80,000) | $320,000 | ~$1,919 | ~$371,000 |
By increasing the down payment, you lower:
- Your loan balance
- Your monthly payment
- Your total interest paid
Reducing the loan amount—by choosing a less expensive home—has the same effect.
Shop, compare, and negotiate mortgage rates
Rates and fees vary by lender, even for the same borrower. Comparing multiple offers can reveal meaningful savings.
- What’s the interest rate and APR?
- Are points included or optional?
- How long is the rate lock?
- Are there lender credits available?
How rate quotes can differ:
- Same rate, different fees
- Lower rate with points vs. higher rate with credits
- Shorter vs. longer rate-lock periods
Comparing at least three lenders helps ensure you’re seeing competitive pricing.
Using points, extra payments, and refinancing
Once you have a mortgage, there are still ways to reduce how much interest you pay.
| Strategy | How it works | Best for |
| Mortgage points | Pay upfront fees to lower your interest rate | Buyers planning to stay long-term |
| Extra principal payments | Reduce the loan balance faster, cutting interest | Borrowers with extra cash flow |
| Refinancing | Replace your loan with a lower-rate mortgage | When rates drop or credit improves |
Key takeaway: Lowering your balance earlier—or securing a lower rate later—reduces the amount of interest your loan can generate over time.
Taken together, these strategies can significantly reduce the true cost of homeownership—often without changing the home you buy, just how you finance it.
Frequently asked questions about mortgage interest
1. How exactly do lenders calculate the interest portion of my mortgage payment?
Lenders calculate interest using your remaining loan balance and annual interest rate, then divide by 12 for monthly payments.
Mini example:
- Loan balance: $300,000
- Annual rate: 6% (0.06)
- Monthly rate: 0.06 ÷ 12 = 0.005
- Monthly interest: $300,000 × 0.005 = $1,500
The rest of your payment goes toward principal based on your amortization schedule.
2. What would my payment look like on a $500,000 mortgage for 30 years?
Here’s a ballpark look at monthly principal-and-interest payments:
| Rate | Monthly payment |
| 5% | ~$2,684 |
| 6% | ~$2,998 |
| 7% | ~$3,327 |
Higher rates increase both the monthly payment and the total interest paid over time.
3. If a loan has 6% interest, how much does borrowing $10,000 really cost?
It depends on how long you take to repay it.
- Simple annual interest: $10,000 × 6% = $600 per year
- 5-year amortized loan: Higher monthly payments, lower total interest
- 10-year amortized loan: Lower monthly payments, higher total interest
Longer terms reduce monthly cost but increase total interest paid.
4. What is the approximate monthly cost of a $300,000 mortgage at 6%?
For a standard 30-year term:
- Monthly interest rate: 6% ÷ 12
- Estimated monthly P&I payment: ~$1,799
Property taxes, insurance, and HOA fees would be added on top of this amount.
5. Does my lender charge mortgage interest based on a daily or monthly calculation?
Most mortgages accrue interest daily, even though payments are due monthly.
- Daily accrual: Interest builds each day based on your balance (most common)
- Monthly calculation: Interest is applied once per month (less common)
Paying earlier can slightly reduce interest when daily accrual applies.
6. How do fixed-rate and adjustable-rate loans change what I pay in interest over time?
- Fixed-rate loans: Interest rate stays the same, creating predictable payments
- Adjustable-rate loans: Rates can rise or fall after an initial fixed period
ARM example: A 5/1 ARM may start at 5% for five years, then adjust annually—potentially increasing payments if rates rise.
7. What are the best ways to cut down the total mortgage interest I’ll pay?
Quick wins:
- Improve your credit before applying
- Compare multiple lenders
- Make extra principal payments
Bigger moves:
- Increase your down payment
- Choose a shorter loan term
- Refinance to a lower rate when possible
Reducing either your rate or your loan balance earlier has the biggest impact on long-term interest costs.
The post How Does Mortgage Interest Work? appeared first on Redfin | Real Estate Tips for Home Buying, Selling & More.
from Redfin | Real Estate Tips for Home Buying, Selling & More https://www.redfin.com/blog/how-does-mortgage-interest-work/
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