How Mortgage Interest Is Calculated, Month by Month
Here is the sentence that explains almost everything about mortgage interest: it is charged on the balance outstanding, not on the amount you originally borrowed.
Every counterintuitive thing about mortgages follows from it. Why the early years feel like nothing is happening. Why an overpayment in year two saves several times what the same amount saves in year twenty. Why a longer term costs so much more in total while costing less each month.
The monthly cycle#
Each month, three things happen in a fixed order. The lender calculates interest on the balance. Your payment arrives. Whatever is left of the payment after the interest reduces the balance. Then the cycle repeats against a slightly smaller number.
- Interest for the month equals the balance multiplied by the monthly rate.
- The payment is applied: first to the interest, then to the capital.
- The balance falls by the capital portion.
- Next month’s interest is charged on the new, smaller balance.
Because the balance falls slowly at first, so does the interest charge — which is why progress feels invisible in the early years and accelerates later.
A worked month#
Balance 200,000, nominal rate 4.8%, so the monthly rate is 0.4%. Interest for the month is 800. If the payment is 1,146, then 346 reduces the balance, leaving 199,654. Next month the interest is 798.62 and 347.38 goes to capital. The shift is small each month and relentless over three hundred of them.
| Month | Balance at start | Interest | Capital repaid |
|---|---|---|---|
| 1 | 200,000 | 800.00 | 346.00 |
| 2 | 199,654 | 798.62 | 347.38 |
| 60 | 174,900 | 699.60 | 446.40 |
| 180 | 118,400 | 473.60 | 672.40 |
| 300 | 1,141 | 4.56 | 1,141.00 |
Illustrative figures rounded for readability. The pattern rather than the decimals is the point.
Annual, monthly and daily interest#
Markets differ in how the charge is applied within the year, and the difference is small but real. Monthly rest — recalculating the balance monthly — is the most common. Daily rest applies interest on the actual balance each day, which makes overpayments effective immediately rather than at the next monthly point. Annual rest, once common, is now rare and is worse for the borrower.
| Method | How it works | Effect on you |
|---|---|---|
| Daily rest | Interest calculated on the balance each day | Overpayments count immediately |
| Monthly rest | Balance recalculated monthly | Overpayments count at the next cycle |
| Annual rest | Balance recalculated once a year | An overpayment can sit uncredited for months |
If you plan to overpay regularly, ask which method the lender uses. On daily rest an overpayment starts saving the day it lands.
Why the nominal rate is divided by twelve#
Dividing the annual nominal rate by twelve is a convention rather than a compounding calculation. A true monthly equivalent of a 4.8% annual effective rate would be slightly under 0.4%, because compounding twelve times produces slightly more than the annual figure. Lenders in most markets quote a nominal annual rate and divide it by twelve, and that is what our calculator does — with one exception.
- Most markets quote a nominal annual rate; monthly rate equals it divided by twelve.
- Turkish lenders quote a monthly rate directly, so the calculator uses it as given and shows the annual equivalent alongside.
- The annual effective rate is always slightly higher than the nominal, because of compounding.
- APR is calculated on the effective basis and includes fees, which is why it exceeds the nominal rate.
This is why three different percentages can describe the same loan without any of them being wrong. Check which one you are looking at before comparing.
What this means in practice#
- Overpay early if you overpay at all — the same amount removes interest from every remaining month.
- A rate rise hurts most when the balance is largest, which is the start of the term.
- Shortening the term saves more than reducing the payment when you overpay; ask the lender which they apply.
- On daily rest, timing an overpayment before a monthly cycle is worth marginally more.
- The total interest figure — not the monthly payment — is the number that shows what the term choice costs.
Our calculator prints the year-by-year split for exactly this reason. The monthly payment is what you can afford; the interest column is what you are buying.
Frequently asked questions
Is mortgage interest calculated on the original amount or the balance?
On the balance outstanding. Each month the lender multiplies what you still owe by the monthly rate, and that is the interest for that month; the rest of your payment reduces the balance. Because the balance falls, the interest charge falls with it and the capital portion of a constant payment grows. This is the single fact that explains amortisation, why early years feel slow, and why an early overpayment is worth so much more than a late one.
What is daily interest on a mortgage?
Daily rest means the lender calculates interest on the actual balance each day rather than on a balance fixed once a month or once a year. The practical difference is that an overpayment starts reducing your interest the day it arrives, instead of waiting for the next monthly recalculation. If you intend to overpay regularly, it is worth asking which method a lender uses before choosing a product.
Does overpaying my mortgage really save that much?
Yes, and much more if you do it early. An overpayment removes that amount of balance from every single remaining month, so its saving compounds across the rest of the term — which is why the same sum overpaid in year two can save several times what it saves in year twenty. Two things to check: whether your lender allows the overpayment without an early repayment charge, and whether it reduces the term or the monthly payment. Reducing the term saves substantially more.
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