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Writer's pictureMark Oliver

How Is Interest Calculated On A Home Loan?

Although it might sound quite a complex process it's actually not that difficult. If you're interested in paying off your home loan quicker and saving some money then this is an important calculation to understand (I'll explain more below).


First things first


To figure out how much interest you pay each month, you need to know the following:

  • Your interest rate

  • Loan balance

How it's calculated


Interest on your home loan is generally calculated daily on the balance of your loan and then charged to you at the end of each month or payment cycle (weekly, fortnightly etc.). Your bank will take the loan balance at the end of each day and multiply it by the interest rate that applies to your loan, then divide that amount by 365 days (or 366 in a leap year). Let's give you an example:


Loan balance = $450,000

Current annual interest rate = 2.5%

Days in the year = 365


Daily interest rate = (450,000 x (2.5 / 100)) / 365 = $30.82


At the end of the month (or your payment cycle) they add all these figures together which makes up the amount of interest you see on your statements



So how can knowing this save you money?


Most people have a Principal & Interest loan which means you are paying down your loan over the loan term, so at the end of the period (say 25 years) you don't owe any further money and you own your home.


By knowing that the bank calculates the interest rate daily the more frequent your repayments the less interest you have to pay as the interest amount will be calculated daily on the lower balance. See the table below to see how the interest amount drops after each monthly payment:

Now imaging if you paid the balance down quicker and more frequently, this would greatly affect the amount of interest you have to pay back.


Here's one solution on how you can easily achieve it; Most people have heard of an offset account but are not sure how they work or what they do. Quite simply the money you have in your offset account is reduced from the loan balance you owe which means you pay less interest. For example:


Let's say you have a $450,000 loan at 2.5% over 25 years as above on monthly repayments, but this time you have $20,000 (your rainy day fund) sat in your offset account, over 25 years this would save you $21,333.77 in interest repayments which reduces your loan term by 1 year 11 months!


There are some catches to using an offset account in that most lenders charge an annual fee of around $350. So if you don't have enough money sat in your offset account to at least save you $350 in interest then it's costing you more money for this feature.


If you would like to find out more information on any of the above or would like to see how we can help you with your mortgage Contact us.

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