Calculating interest on a mortgage

[simone07]

Let's take in a 10.000 euro mortgage with a fixed interest rate of 2,5%, where the interest is non-compound, and there is a 5-year repayment period.

In year 1 there will be a payment of 2.000 euros going towards paying the principal (10.000 euros / 5 years). There will also be an interest of 250 euros (2,5% x 10.000 euros).

My question is about how the interest gets calculated in the following years. Does it get calculated on the original sum borrowed [case 1] or on the remaining balance [case 2]?

In both cases, we'll look at year 2, where the remaining balance is 8.000 euros.

[case 1]: In year 2 there will be a payment of 2.000 euros going towards paying the principal (10.000 euros / 5 years). There will also be an interest of 250 euros (2,5% x 10.000 euros).

[case 2]: In year 2 there will be a payment of 2.000 euros going towards paying the principal (10.000 euros / 5 years). There will also be an interest of 200 euros (2,5% x 8.000 euros).

 

[herve]

@simone07 The way most mortgages work is the following:

While repaying a loan, your monthly payments are fixed (for fixed rate interest loans).

Initially (first few months), the ratio of principal payment to interest payment is small (i.e. your first payment will pay off more interest, and less principal), and over time the ratio increases.

The process of splitting the monthly payments in this way (keeping monthly payments fixed, and changing the ratio of interest and principal components in the payment) is called amortization.

You can compute the total interest you will pay over the entire tenure of the loan, using the mortgage loan calculator here.

Putting in your numbers, of a $10k loan at a 2.5% interest rate for 5 years, you're looking at $177 per month. Overall, you'd end up paying $648 in interest over the tenure of the loan.

So, in your first year, you'll end up paying $2130, and the same amount every year for the next 4 years as well.

you can compute it in excel as well, using the formula in a cell

=PMT(2.5/100/12, 5*12, -10000)

simply change the bold values of interest rate, years, and amount you want to borrow for a different scenario.

 

[thenextsteps]

@herve This is the proper answer

 

[vryworrisome]

@simone07 I don't have a fixed interest rate but I think it works the same as the variable one, the interest you owe is calculated based on the remaining value which is why you should always see more money going towards your principal as you pay monthly.

 

[simone07]

@vryworrisome I also don't have a fixed interest rate, I just made that example so the rate wouldn't change and the example would be simpler. So it should follow the second case.

And since you have a variable rate mortgage, I'd really appreciate it if you could also help with something else.

I have a court decision that says that the rate should be "the average interest rate of a mortgage loan with a variable interest rate, which will be valid at the time of repayment, according to the statistical bulletin of the Bank of Greece [3.63% for Nov. 2022] adjusted by the rate of the Main Refinancing Operations of the European Central Bank [2.00% for Nov. 2022]".

I am confused as to what "adjusted by" means. Am I supposed to add the 2 rates together and apply that to the principal? Basically, what I'm asking is how have the ECB rate hikes impacted you and the interest on your variable-rate mortgage.

 

[vryworrisome]

@simone07 Yes, you're supposed to add the 2 rates and apply that to your current loan value. I have something similar in my country, Romania, it's called IRCC which varies and this one is added on top of the 3% that the bank has as a margin. So if the IRCC is 5% then I would have to do 8% of whatever I have left, let's day 100000 = 8000 is the interest for 1 year = so I would pay 666.66 per month in interest.