How Mortgage Payments Are Calculated: Amortization Math Explained

The Standard Mortgage Amortization Formula

Every fixed-rate mortgage repayment is computed using a standard compound interest formula. This formula ensures that over a set term (such as 25 or 30 years), you make equal monthly payments that completely pay off both the loan principal and all interest accrued.

The formula is written as: M = P * [r(1+r)^n] / [(1+r)^n - 1]

Where: M is your monthly payment, P is the principal loan amount, r is the monthly interest rate (annual interest rate divided by 12 months), and n is the total number of payments (loan term in years multiplied by 12).

Principal vs. Interest: The Shifting Balance

In the early years of a mortgage, your loan balance is at its highest, meaning that most of your monthly payment goes toward paying off the interest. Only a small fraction goes toward reducing the principal balance.

As the years progress and the principal is chipped away, the interest charge decreases. Consequently, a larger percentage of your monthly payment goes toward the principal. By the final years of your mortgage, almost your entire payment is dedicated to principal repayment.

How Extra Payments Speed Up Repayment

Because interest is calculated based on your remaining principal, any extra payment you make goes directly toward reducing the principal balance. This reduces the base on which future interest is calculated.

By making even small overpayments, you can shave years off your mortgage term and save thousands in interest costs. However, check your lender's policy as many restrict overpayments to 10% of the balance per year before penalties apply.