How Mortgage Payments Are Calculated
Your monthly payment never changes, but what it does changes every single month. Understanding that split is what makes overpaying make sense.
By Rohit Sharma, Founder, SEOShouts
A repayment mortgage is engineered so that a fixed monthly amount clears both the interest and the balance over an agreed term. The payment stays level; the proportion going to interest versus principal shifts month by month. Nearly everything people find surprising about mortgages follows from that shift.
The amortisation formula
M = P × [ i(1 + i)^n ] ÷ [ (1 + i)^n − 1 ]
P is the loan amount, i the monthly interest rate (annual rate ÷ 12), and n the total number of payments (years × 12).
On a £250,000 loan at 5 per cent over 25 years: i = 0.05 ÷ 12 = 0.004167, and n = 300. Running the formula gives a monthly payment of about £1,461. Over the full term that is roughly £438,000 paid on a £250,000 loan, so £188,000 of it is interest.
Why early payments barely touch the balance
Interest each month is charged on the balance still outstanding. In month one the balance is the whole loan, so the interest portion is large and very little is left to reduce what you owe.
| Payment | Interest | Principal | Balance after |
|---|---|---|---|
| 1 | £1,042 | £419 | £249,581 |
| 60 (year 5) | £951 | £510 | £227,700 |
| 180 (year 15) | £625 | £836 | £149,200 |
| 300 (final) | £6 | £1,455 | £0 |
In the first month, 71 per cent of the payment is interest. By the final month it is under one per cent. The curve is slow at first and then accelerates, which is why the halfway point in time is nowhere near the halfway point in balance.
What overpaying actually does
An overpayment goes entirely against the principal. Because every future interest charge is calculated on the balance, reducing the balance today removes interest from every remaining month. That is why overpayments made early are worth far more than the same amount paid later.
On the loan above, adding £150 a month from the start clears the mortgage about four years early and saves roughly £38,000 in interest. The same £150 a month started in year 15 saves closer to £9,000.
What the payment does not include
The formula covers principal and interest only. The amount that actually leaves your account usually also carries buildings insurance, and in many countries property tax collected through an escrow account. Where a deposit is under 20 per cent, mortgage insurance is often added until enough equity is built.
- Principal and interest, from the formula above.
- Property tax, often collected monthly and held in escrow.
- Buildings insurance, usually a lender requirement.
- Mortgage insurance, where the deposit is below the lender threshold.
- Service charge or ground rent, for leasehold property.
Term length is the other lever
Shortening the term raises the monthly payment but cuts total interest sharply, because there are fewer months for interest to accrue. The same £250,000 at 5 per cent over 15 years costs about £1,977 a month, £516 more, yet total interest falls from £188,000 to roughly £106,000.
Frequently asked questions
Why is so much of my early mortgage payment interest?
Interest is charged on the outstanding balance, which is at its largest at the start. As the balance falls, the interest portion falls with it and more of each fixed payment goes to principal.
Is it better to overpay or shorten the term?
They produce a similar result. Overpaying voluntarily keeps flexibility, since you can stop if money is tight. Formally shortening the term locks in the higher payment and sometimes secures a better rate.
Does making one extra payment a year make a real difference?
Yes. On a 25-year mortgage, one extra monthly payment each year typically removes around three years from the term, because every pound of principal removed also removes the interest it would have attracted.
Calculators from this guide
About the author
Rohit Sharma is the founder of SEOShouts, a search consultancy in India, and has worked in technical SEO and content strategy since 2014. He builds and maintains Calcshark.