There are lots of mortgage calculators available that will tell you how much you should expect to pay each month when repaying your mortgage. But do you know why the repayment is that amount? And how much of your monthly payment goes towards repaying the loan versus paying interest on the loan?
If you want to know actually how much of your home you own and how much of your mortgage you've repaid, it is important to know how mortgage payments work.
How mortage payments DON'T work
The simplest way to structure payments would be to repay the same amount of the mortgage each month, and pay interest on the remaining outstanding mortgage.
Customise the examples for your mortgage:
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So for instance, if your mortgage is £100,000 which you are repaying over 30 years at a 3% annual interest rate, you'd repay £3,333 per year and pay 3% interest on the remaining amount each year.
This is straightforward but not how mortgage payments are structured - for a good reason. The chart below shows your annual payments. They decrease over time as there is less mortgage outstanding so your interest payments decline:
Using this method, whilst the payments decrease over time, they are highest right when you move in. As salaries tend to go up as people get older, having your mortgage payments start high and go down would make mortgages much less affordable.
How mortage payments actually work
Instead, mortgage payments are structured to stay constant over the term of the mortgage (assuming interest rates don't change).
Firstly, the monthly repayment is calculated using this funky formula:
Which results in...
Your monthly mortgage cost:
Annually, this is:
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Each month, a portion of your mortgage payment is used to pay the interest on the outstanding mortgage, whilst the rest is used to repay the mortgage:
Initially a lot of your monthly payment goes towards paying the interest. Later on, a larger proportion of payments go towards repaying the mortgage instead. So if you think of paying your mortgage as buying more of your house from the bank, to start with you are hardly buying anything!
How much of my mortgage have I actually paid off?
It is important to know how much of your mortgage is outstanding, because that affects how much cash you get if you sell your home before the end of the mortgage term (30 years).
When you're half-way through your mortgage term, you've not paid off half your mortgage.
Since initial payments go mainly to pay interest rather than repaying the loan, you can be 2/3 - or more! - of the way through the term before you've paid off half your mortgage. The exact amount depends on the mortgage interest rate. Try changing the interest rate below to see the effect on how long it will take to repay half your mortgage:
Wow, this is complicated
Agreed - and so far we've actually simplified things!
Firstly, the interest rate is unlikely to remain constant throughout the mortgage term. Generally your monthly payments will change in line with the Bank of England's base rate.
This chart shows the effect of interest rates on your monthly payment:
Whilst an interest rate of 15% may seem impossible, the official Bank Of England interest rate did hit 14.875% at the end of 1989, for a year.
Secondly, the above assumes you've chosen a repayment mortgage. Another option is an interest-only mortgage. Using this option you'd pay £500 a month instead of £500 a month for the repayment mortgage. However at the end of the term you'd need to repay the entire mortgage (£100,000!) in one go. Therefore the bank would want to see a comprehensive plan for how you intend to repay them at the end of the term.
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