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How to calculate mortgage interest

The amount of mortgage interest you pay doesn't have to be set in stone.

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By

Veronica Ott

Edited by

Joelle Grubb

Updated

Fact checked

There are several factors that affect how much interest you pay from the interest rate your lender sets to the loan term you sign up for, and you can save thousands by taking advantage of those terms.

Why should I calculate mortgage interest?

Mortgages are among the largest financial obligations most Canadians hold. The calculation of interest is quite complex, but it is important to consider because it can help you plan, make financial choices and catch errors. In addition, knowing your mortgage interest amount means you know the real cost of financing which can be ambiguous at face value. Once you know the cost, you can make educated financial decisions, such as whether to refinance, ask for different conditions or choose another mortgage lender. By the end of this guide, you’ll know how to calculate interest on a mortgage.

What factors affect the amount of interest you pay?

The following factors will affect the amount of your mortgage interest payments:

  • The mortgage interest rate. This is the rate the lender charges you as the cost of financing. Even a small difference in the interest rate can add up to thousands over the life of the loan.
  • The prime interest rate. The interest rate on your loan is often connected to the prime rate, or overnight rate, set by the Bank of Canada. The prime rate dictates the rate banks lend money to each other overnight. If you have a variable interest rate, paying attention to the prime interest rate can help you predict what your interest rate will do.
  • The amount you borrow. The more you borrow from your bank, the more interest you’ll need to repay. For example, 5% of $1 million will always be a larger amount than 5% of $500,000.
  • The outstanding loan amount. As you gradually pay off the money you borrow, you will be paying interest on a smaller loan amount and your interest payments will slowly reduce.
  • The loan term. The time you take to pay off your loan will affect the amount of interest you pay – paying your loan off over a shorter period of time will minimize your interest.

Calculate mortgage interest

Most people use a mortgage calculator to determine mortgage interest for simplicity. However, you can calculate mortgage interest using a pen and paper as well.
Before proceeding with the calculation, you need to determine whether your mortgage rate is fixed or variable.

  • Fixed rate mortgages. With fixed-rate mortgages, you are paying an agreed-upon interest rate every month. This rate doesn’t change until the mortgage term is up or you refinance your mortgage. In Canada, fixed rate mortgages are compounded semi-annually. This means that the posted rate and actual interest rate you pay are different due to compounding. As a general rule of thumb, the more a mortgage is compounded, the higher the monthly interest payment will be. Compounding increases the cost of financing which means your quoted fixed rate will be slightly higher to account for compound interest.
  • Variable rate mortgages. The compounding period varies depending on your lender and agreement, usually semi-annually or monthly. Refer to your mortgage agreement or ask your lender to determine how often your interest is being compounded. Your interest payments will vary based on whatever benchmark is being used, typically the prime rate. If you’re having trouble finding the interest rate of your mortgage, ask your lender for the effective rate. An effective rate is usually higher than your posted or quoted rate, but reflects the true cost of financing. Once you understand the interest rate of your mortgage, you can calculate the total payment amount using the following formula:
    Total payment = (principal) / (number of months/number of payments in term)
    This is the total payment including the principal and interest. This calculation doesn’t consider other costs related to your mortgage, such as property taxes, insurance or utility bills. Unfortunately, every mortgage payment has a different ratio of principal and interest, even though the total payment remains the same. In order to calculate the interest per payment, you would need to create an amortization schedule which can be quite complicated.

    If you would like to calculate the interest over the course of a year, use the below formula:

    Unpaid balance x interest rate = interest payable

Principal and interest vs interest-only

Another factor that impacts your mortgage payment is whether you’re making principal and interest payments or interest only payments.

  • Principal and interest payments. These are the most common way to pay off a mortgage. In this case, a portion of your monthly payment goes towards the principal and the other portion goes towards the interest you owe.
  • Interest only payments. These loans are designed to make interest only payments for a certain period of time. Property investors with an investment mortgage or those building a new property often use interest only mortgage structures. The reason is that the monthly payment is typically reduced.

Example: Susie's mortgage payments

Susie is borrowing $700,000 to buy a house and she wants to save as much money on interest as possible. She decides to calculate the impact on the total cost of the mortgage using 2 APRs with a 0.25% difference.

If she can find a loan with an interest rate of 4% APR on a 30-year loan term, her monthly principal and interest payments will be $3,328.63. The total interest she will end up paying over the life of the loan is $498,307.00.

If Susie finds a loan with a marginally lower interest rate of 3.75% APR, her monthly payments will be $3,230.31 and the total interest over the life of the loan will be $462,915.00. With the lower rate, Susie will save $35,392.00 in interest costs.

* This is a fictional, but realistic, example.

How to save interest on your mortgage

Now that you know a bit more about how interest is calculated let’s look at the ways you can actually pay less of it.

  • Get the best rate. Shopping around for a better interest rate can save you thousands of dollars. If you already own a home, you may want to consider refinancing with your current lender or switching to a new lender.
  • Make frequent payments. Because there are a little over 4 weeks in a month, if you make bi-weekly payments instead of monthly payments, you’ll end up making 2 extra payments a year.
  • Make extra payments. The quicker you pay down your loan amount, the less interest you’ll need to pay on your smaller outstanding balance. If you have a variable interest rate, you can save even more by making extra payments when interest rates are low. Be mindful of early repayment penalties on closed mortgages.
  • Choose a shorter loan term. The longer you take to pay off your loan, the more interest you’ll end up paying. Remember, banks calculate interest on your loan amount daily, so choosing a 25-year loan term instead of 30 years can make a big difference.

Compare mortgages in Canada

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Name Product Interest Rate (APR) Loan Term Min. credit score Provincial availability
Neo Mortgage
Neo Mortgage
5.59%
5-year fixed rate
Varies
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Get a new mortgage, refinance or renew in just minutes. 100% online.
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nesto Mortgages
CASHBACK
nesto Mortgages
5.44%
5 Year Fixed Rate
680
All of Canada
Switch to nesto and get up to $4,300 cashback.
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Homewise Mortgages
Homewise Mortgages
Varies
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600
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BMO Mortgages
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6.51%
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Lock in a rate for up to 130 days - the longest of any major bank in Canada.
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Bottom line

Understanding how to calculate interest on a mortgage can save you dollars in the long run. Choosing the most competitive home loan and making extra payments can help you cut tens of thousands off the cost of your home.

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