How Do Banks Calculate the Interest on My Home Loan?

Understanding Mortgage Interest: Fixed, Variable, and Split-Rate calculations.

For some new borrowers, there are certain parts of the mortgage process that can seem like a bit of a mystery. For instance, figuring out how banks actually calculate the interest on your home loan often seems more complicated than it actually is.

Whether you’re locked into a fixed interest rate, you have a variable rate, or you’ve got a split-rate loan, here’s how interest rates are calculated on your mortgage.

How do banks calculate interest on home loans?

When you take out a mortgage, you typically can choose between a principal and interest or interest-only repayment schedule. The amount of interest you’re charged depends on several different factors, including:

  • The principal, or the total amount you’ve borrowed
  • The term of your home loan
  • The repayment type (EG. principal and interest or interest-only loans), and
  • The type of interest rate (EG. variable interest rates vs fixed interest rates).

With that said, some lenders have their own way of calculating interest rates, but you can always check in with them to see how they work out your repayments.

And don’t forget, your total repayments are likely to be more than just your interest repayments because you’ll also need to be contributing towards the outstanding loan balance. That is unless you have an interest-only home loan, but this option isn’t offered by all banks and lenders.

How to calculate your daily interest repayments

Working out your daily interest rate requires one simple formula:

(P x R) / T = I


        P = Principal or the outstanding balance of your home loan,

        R = Interest rate, which is the percentage rate divided by 100,

        T = The amount of time in days, which is usually 365 if you’re charged annually, and

        I = Interest or the daily interest charged.

For example, if your home loan figures are as follows:

        P = $600,000

        R = 4.5%

        T = 365

Then the formula would look like this:

($600,000 x 0.045) / 365 = $73.97 interest charged daily

If you wanted to work out how much your monthly interest repayments were, you would just multiply the daily interest figure by however many days there are in that given month. Because the number of days in each month can change, your monthly interest repayments are also likely to fluctuate with them.

If you’re interested in learning more about how interest rates are determined in the first place, you can read more about it here. We’ve also written a blog that explores how RBA changes affect your interest rate.

How to save on your interest repayments

While it might not seem like a big deal, understanding how your interest rates are determined provides you with valuable information about your loan that could potentially save you money. Here are some of the ways you can curb the amount of interest you pay on your loan.

Make extra repayments

Some home loans might allow you to make extra contributions on top of your minimum repayments. Putting a little extra cash towards your mortgage can help you to chip away at your principal quicker, which can help to reduce your interest.

If you have access to a redraw facility, you can access these extra repayments in the future in the event you need to tap into a little extra cash. Just be sure to check with your lender in case there are any fees associated with making withdrawals or if there are any potential tax implications that are worth knowing about beforehand.

Use an offset account

An offset account is a separate transaction account that’s linked to your home loan. Offset accounts work in the same way as a regular transaction account, so you can still deposit money, withdraw cash, and make purchases using a linked debit card.

The money saved in your offset account can be used to offset the principal of your home loan each day. That way, your daily interest is calculated based on the reduced amount, rather than the full outstanding balance of your loan, helping you to save on interest repayments.

For example, if you have a principal of $500,000 and you have $65,000 in your offset account, you would only be charged interest on the reduced amount of $435,000.

Please note we currently do not offer offset accounts at Unloan, but a linked-CommBank offset account is coming soon. However, you can save interest and benefit from our redraw facility if you’ve made additional repayments on your home loan.

Make more frequent repayments

Calculating your interest repayments can help you compare how different repayment frequencies can impact the amount of interest you repay. Although it might not seem like much, you might work out that you’re better off making repayments on a weekly, fortnightly, or monthly basis.

With that said, not all lenders offer the option to adjust your repayment schedule, so be sure to check in with them to see if it’s a possibility.

When is interest calculated on a home loan?

Most banks and lenders calculate interest daily based on the outstanding balance. Interest is then charged on either a fortnightly or monthly basis, depending on how you’ve set up your repayment schedule. So, even if your repayments stay the same, your monthly repayments can fluctuate depending on how many days are in a month.

Unloan’s mortgage calculators

We get that maths isn’t for everyone, which is why we developed our very own mortgage calculators. Use our calculators to quickly and easily work out how much you could be saving and what your potential repayments could look like when you switch to Unloan. You can even see how making additional repayments can impact your loan and how our annual discount works over the life of your loan.

Learn more about Unloan’s interest rate offering and loan features. If you’re after a little more info, get in touch with one of our friendly lending specialists.

This article does not have regard for the financial situation or needs of any reader and must not be relied upon as financial product advice. As this information has been prepared without considering your objectives, financial situation or needs, you should, before acting on this, consider the appropriateness to your circumstances.

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