{"id":1574,"date":"2021-08-24T14:09:08","date_gmt":"2021-08-24T21:09:08","guid":{"rendered":"https:\/\/www.nerdwallet.com\/ca\/?page_id=1574"},"modified":"2024-05-16T10:46:01","modified_gmt":"2024-05-16T17:46:01","slug":"how-does-mortgage-interest-work","status":"publish","type":"page","link":"https:\/\/www.nerdwallet.com\/ca\/mortgages\/how-does-mortgage-interest-work","title":{"rendered":"How Does Mortgage Interest Work?"},"content":{"rendered":"\n

Mortgage interest is a fee you pay to a mortgage lender for the use of their money. <\/p>\n\n\n\n

If you have a fixed-rate mortgage, your interest payments will be predictable during the length of your mortgage\u2019s term. If you have a variable-rate mortgage, they could change.<\/p>\n\n\n\n

Regardless of your mortgage type, the main takeaway for borrowers is universal: The interest you pay on a mortgage can easily be as much as the cost of the home itself. Knowing how interest works is a crucial step to understanding how much mortgage you can afford<\/a>.\u00a0<\/p>\n\n\n

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How mortgage interest rates are set<\/strong><\/h2>\n\n\n\n

The mortgage rate you\u2019re offered by a lender is specific to you and based on many factors. Some factors \u2014 including your credit score<\/a>, income and employment history \u2014 are under your control. Other factors, such as the prime interest rate<\/a>, which is a reflection of the country\u2019s economic condition, are outside of your control. <\/p>\n\n\n\n

How mortgage interest works: Fixed rates<\/strong><\/h2>\n\n\n\n
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  1. Your mortgage principal \u2014 the amount you borrow \u2014 starts accruing interest at your agreed-upon rate as soon as the loan closes. The process works similarly to how you earn interest on deposits in a savings account except, in this case, you pay the bank interest instead of the bank paying you. <\/li>\n\n\n\n
  2. When it\u2019s time to make your first mortgage payment<\/a>, the interest is paid first. The remainder of the payment goes toward the principal.\u00a0\u00a0<\/li>\n\n\n\n
  3. The cycle begins again. However, now the beginning principal is slightly smaller than when your mortgage began, thanks to the portion of last month\u2019s payment that paid down the principal. As a result, the amount of interest that accrues when next month\u2019s payment is due will be slightly less than last month\u2019s payment, and the percentage of that payment going toward your principal will be slightly larger.  <\/li>\n\n\n\n
  4. The cycle continues. With a fixed mortgage, your interest rate \u2014 and mortgage payment \u2014 stays the same for your entire term, even though the amount allocated toward interest changes over time.<\/li>\n<\/ol>\n\n\n\n

    Nerdy Tip: <\/strong>If you use an online mortgage calculator<\/a>, be sure it\u2019s built for Canadians. In Canada, interest is compounded semi-annually; in the U.S. it\u2019s not. You\u2019re not going to get accurate numbers if you use a U.S. calculator.  <\/p>\n\n\n\n

    Mortgage interest example<\/h3>\n\n\n\n

    To visualize how mortgage interest works, look at an amortization table. Don\u2019t let its wonky name intimidate you. An amortization table is simply a monthly breakdown of where your money goes each time you make a mortgage payment \u2014 and how many payments it will take to repay it completely. <\/p>\n\n\n\n

    Consider the following home-purchase scenario: <\/p>\n\n\n\n

    Home value:<\/strong> $350,000<\/p>\n\n\n\n

    Down payment:<\/strong> $70,000 (20%)<\/p>\n\n\n\n

    Value of loan:<\/strong> $280,000<\/p>\n\n\n\n

    Interest rate:<\/strong> 5%<\/p>\n\n\n\n

    Amortization period<\/strong> (the time it\u2019ll take to pay off your loan completely): 25 years<\/p>\n\n\n\n

    Monthly mortgage payment:<\/strong> $1,628.49<\/p>\n\n\n\n

    This mortgage will be paid off after 300 payments (25-year amortization * 12 payments per year). The table below shows the first three and the final three monthly payments. For each payment, you can see the outstanding principal at the beginning of each month, followed by a breakdown of how the $1,628.49 monthly payment is divided between interest and principal repayment. <\/p>\n\n\n\n

    <\/td>Principal amount<\/strong><\/td>Interest payment<\/strong><\/td>Principal repayment<\/strong><\/td>Remaining principal<\/strong><\/td><\/tr>
    Month 1<\/strong><\/td>$280,000<\/td>$1,154.70<\/td>$473.80<\/td>$279,526.20<\/td><\/tr>
    Month 2<\/strong><\/td>$279,526.20<\/td>$1,152.74<\/td>$475.75<\/td>$279,050.45<\/td><\/tr>
    Month 3<\/strong><\/td>$279,050.45<\/td>$1,150.78<\/td>$477.71<\/td>$278,572.74<\/td><\/tr>
    Month 298<\/strong><\/td>$4,845.46<\/td>$1,608.51<\/td>$19.98<\/td>$3,236.95<\/td><\/tr>
    Month 299<\/strong><\/td>$3,236.95<\/td>$1,615.15<\/td>$13.35<\/td>$1,621.81<\/td><\/tr>
    Month 300<\/strong><\/td>$1,621.81<\/td>$1,621.81<\/td>$6.69<\/td>$0
    <\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

    In the above example, the borrower would pay $208,548.19 in interest over the entire mortgage. Including the beginning principal of $280,000, the total amount paid would be $488,548.19.<\/p>\n\n\n\n

    In reality, your interest rate will likely change each time your mortgage term expires and you renew your mortgage<\/a>, so the projected amount of interest you\u2019ll pay will adjust a few times during the course of your entire mortgage.<\/p>\n\n\n

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    How mortgage interest works: Variable rates<\/h2>\n\n\n\n

    The fundamentals of mortgage interests are the same for a variable-rate mortgage<\/a> \u2014 a portion of each mortgage payment goes toward interest and the rest goes toward the principal. <\/p>\n\n\n\n

    The difference is that while fixed rates are locked for the duration of the term, variable rates can fluctuate up or down, and they can change multiple times during your term. As a general rule, if the Bank of Canada\u2019s prime rate changes, your mortgage interest rate will change with it. <\/p>\n\n\n\n

    Because of this uncertainty, a variable-rate mortgage doesn\u2019t come with an amortization table showing a steady decline in the amount earmarked for interest each month, as you see with a fixed-rate mortgage. With a variable rate, the amount of a mortgage payment going toward interest could be more than the month prior. In some instances, your mortgage payment itself could increase.<\/p>\n\n\n\n

    How to get a lower mortgage interest rate<\/strong><\/h2>\n\n\n\n

    It\u2019s tempting to look at how much house you could have afforded in 2021 or talk about what interest rates will do in the future, but doing that won\u2019t save you a single dollar in mortgage payments. Instead, the best way to get the lowest mortgage rates is to stay focused on the factors under your control. <\/p>\n\n\n\n