How Interest is Calculated

An interest rate is the price of money. A mortgage interest rate is the price of money loaned against the security of a piece of property. When going through a remortgage negotiation it is imperative that you understand how interest is calculated. This helps you understand where the total monthly payment comes from.

Let’s start with this: The rates shown everywhere by lenders are annual rates. Traditionally for home mortgages, the interest payment is calculated monthly. Therefore, the rate is divided by 12 before calculating the payment.

As an example, take a 5 per cent rate, and a loan amount of 100,000. In decimals, 5 per cent is .05 and when divided by 12 it is .0042. Multiply .0042 by 100,000 and you come up with 420 pounds as the monthly interest payment.

Say the borrower pays 520 pounds a month. Then 420 pounds of the total covers interest on the remortgage. While 100 pounds goes toward principal (the original loan of 100,000) of the remortgage loan. Another month later the balance is 99,000 and the interest is 419.58 pounds. The interest rate stays the same, but the interest payment is lower because the principal is lower.

It is important to understand where figures come from and the meaning of terms. This is the only way you can help yourself ultimately reach your financial goals.

See your remortgage specialist today for questions on how to calculate simple interest on any other part of the remortgage process.

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