How is the interest calculated on home loans?

How is the interest calculated on home loans?

Once you’ve obtained a home loan, you will have to pay interest on that loan. In order to pay back your loan with confidence, it’s important for you to understand how interest is calculated on your home loan. 

What is home loan interest?

Let's start with the basics. Home loan interest is essentially the cost you pay for borrowing money from a lender to purchase a home. It's the price tag on the privilege of spreading out your payments over time, rather than shelling out the full purchase price upfront.

How is interest calculated on a home loan

The amount of interest you pay can vary depending on the type of loan and the terms agreed upon, but at its core, it revolves around two key factors: the principal amount and the interest rate.

The principal amount is the initial sum you borrow to purchase your home. The interest rate, on the other hand, is the percentage of the principal that the lender charges as interest over a specific period, usually expressed annually.

Interest on a home loan is typically calculated using one of two methods: simple interest or compound interest.

• Simple Interest: With this method, interest is calculated solely on the principal amount borrowed. Each month, a portion of your payment goes toward the interest accrued, with the remainder reducing the principal. This results in a linear decrease in the total amount owed over time.

• Compound Interest: This method incorporates interest on both the principal amount and any accumulated interest. As a result, the total amount owed grows at an exponential rate, especially if left unchecked over an extended period.

How to calculate interest on a home loan

Now that you have a grasp of the basics, let's roll up our sleeves and tackle the maths behind interest calculation. We’ll keep things simple:

1. Gather the necessary information: To kick things off, you'll need to gather some key details, including the principal amount, interest rate, and loan term (e.g., the duration over which you'll be repaying the loan).

2. Determine the periodic interest rate: If your loan terms specify an annual interest rate, you'll need to convert it into a periodic rate based on your repayment schedule. For example, if you're making monthly payments, divide the annual rate by 12 to obtain the monthly interest rate.

3. Calculate the monthly interest: With the periodic interest rate in hand, you can now determine the amount of interest accruing each month. Simply multiply the outstanding principal balance by the monthly interest rate.

4. Update the principal balance: After calculating the interest for the month, subtract this amount from your total monthly payment. The remainder will go toward reducing the principal balance.

Repeat the process: As you continue making monthly payments, the principal balance will gradually decrease, leading to a reduction in the amount of interest accrued each month. You’ll continue to repeat this until you've paid off the loan in full or decide to embark on another adventure in homeownership.

You have to be a Qantas Frequent Flyer member to apply for a Qantas Money Home Loan. This website contains general advice only. This information has been prepared without considering your objectives, financial situation or needs. You should consider your circumstances before acting on this information.