#### Brendan Burgess

##### Founder

- Messages
- 39,113

*As always, comments, corrections and suggestions for layout very welcome - Brendan*

There have been a few questions on askaboutmoney which have been very difficult to answer without explaining the background to mortgage calculations. For example:

Bank of Scotland offer to write off my arrears. What is the catch? People often confuse interest payments with the full repayment. The purpose of this long thread is to explain the background to how mortgage repayments are calculated in a systematic way.

Subjects covered:

- how repayments are calculated
- checking that you have been charged the correct amount of interest
- the effect of interest rate increases
- Paying a lump sum off your mortgage
- The effect of increasing your monthly repayments
- The effect of reducing your repayments
- how arrears are calculated and dealt with
- My friend says that I can save thousands by paying my mortgage every two weeks instead of every month?

Not covered

- Applying for mortgages
- tax relief
- investment mortgages
- the fairness of interest rates

**The standard repayment or annuity mortgage**

Let’s start with a simple example of a €100,000 mortgage at 4% for 20 years.

You can get the repayments from Karl Jeacle’s excellent Mortgage Calculator

Code:

```
interest capital balance
2001 €3,939.34 €3,332.42 €96,667.58
2002 €3,803.58 €3,468.18 €93,199.40
2003 €3,662.27 €3,609.49 €89,589.91
2004 €3,515.21 €3,756.55 €85,833.36
2005 €3,362.17 €3,909.59 €81,923.77
2006 €3,202.90 €4,068.86 €77,854.91
2007 €3,037.11 €4,234.65 €73,620.26
2008 €2,864.59 €4,407.17 €69,213.09
2009 €2,685.04 €4,586.72 €64,626.37
2010 €2,498.17 €4,773.59 €59,852.78
2011 €2,303.67 €4,968.09 €54,884.69
2012 €2,101.28 €5,170.48 €49,714.21
2013 €1,890.64 €5,381.12 €44,333.09
2014 €1,671.40 €5,600.36 €38,732.73
2015 €1,443.21 €5,828.55 €32,904.18
2016 €1,205.76 €6,066.00 €26,838.18
2017 €958.61 €6,313.15 €20,525.03
2018 €701.41 €6,570.35 €13,954.68
2019 €433.73 €6,838.03 €7,116.65
2020 €155.12 €7,116.64 €0.00
```

Assuming that the interest rate stays the same, the repayment stays the same for the whole 20 years ie.

**€605.98**per month which is €7271.76 per year.

**Each repayment contains an interest and a capital element**

This is a really key concept and is worth dwelling on. The annual cost of a mortgage is the interest you pay on that mortgage. So in year 1 above, the cost of borrowing that money is €3,939.

The capital repayment is a form of saving. The €3,332.42 in capital repaid during the year has reduced your outstanding mortgage to €96,667.

A lot of people say “My mortgage costs me €605 per month”. This is not the same as a tenant who says “my rent is €605 per month”. The rent is the true cost of living in the house. For the home owner, the true cost of the mortgage is the interest element. In the first year above, roughly half the repayment is interest, so the true cost of the mortgage is around €330 per month. By contrast, in 2020, the true cost of the mortgage is only €13 per month in interest.

This is a very important distinction to make. Many people who are struggling with their finances and running up overdrafts and credit card bills are, at the same time, paying capital off their mortgage. So they can be borrowing at Credit Card rates of 16% to pay off a loan which is costing them 4%. This makes no sense if they can get their lender to agree to reduce the capital element of the repayment.

**Checking that you have been charged the correct interest.**

It is very easy to get a rough idea of how much the interest should be on your mortgage. At the early stages, you are not repaying much capital, so the balance at the end of the year will be just a bit below the balance at the start of the year. So in Year 1, the balance is €100,000. The interest rate is 4%, so the interest charged should be around €4,000.

It gets a little bit more difficult in later years. Take 2017 for example. At the beginning of the year, you owed €26,838 and at the end you owed €20,525, so the average balance during the year was about €24,000. 4% of this would be €960.

You can also use this Excel spreadsheet to calculate the interest in a more exact way.

**What happens when interest rates change?**

At the start of year 11 above,

Interest rate|4%

Remaining term|10 years

Monthly repayment|€605

Play around with the Simple Mortgage Calculator to see the effect of interest rate changes on your repayments.