If you’re thinking about buying a home or refinancing your current one, you’ve probably heard the term mortgage interest. But how does it actually work? And more importantly, how does it affect your monthly payments and the total cost of your home?
Understanding how mortgage interest works can help you make smarter decisions when choosing a mortgage and planning your finances. Whether you’re new to the housing market or just need a refresher, this guide breaks it down in clear and simple terms.
What Is Mortgage Interest?
Mortgage interest is the cost you pay to borrow money from a lender to buy a home. It’s expressed as a percentage of the mortgage amount, and it is added to your regular payments. This interest is how lenders make money from providing home loans.
For example, if you borrow $400,000 with an interest rate of 5 percent, you’ll pay interest on that $400,000 balance—at least at the start. Over time, as you pay down the principal (the original amount borrowed), your interest charges will decrease.
Fixed vs. Variable Interest Rates
There are two main types of interest rates on mortgages: fixed and variable.
Fixed-Rate Mortgages
With a fixed-rate mortgage, your interest rate stays the same for the entire term. This means your payments remain predictable and consistent, even if market interest rates go up.
Variable-Rate Mortgages
A variable-rate mortgage, on the other hand, can fluctuate based on changes in the lender’s prime rate. While you may save money if rates go down, your payments could increase if rates rise.
Some homeowners choose variable rates for the potential savings. Others prefer the stability of a fixed rate. The right choice depends on your financial situation and your comfort level with change.
How Is Mortgage Interest Calculated?
In Canada, most lenders calculate mortgage interest using compound interest, which means the interest is calculated on both the original loan amount and the accumulated interest.
However, interest on mortgages is typically compounded semi-annually, not monthly or daily like some other loans. This means that twice a year, the interest is added to your balance for the purposes of calculation.
Here’s a simple example:
If you have a $300,000 mortgage with a 5 percent annual interest rate compounded semi-annually, your lender calculates interest based on that compounding schedule. The exact amount of interest you’ll pay depends on your payment frequency and amortization period.
Amortization and Interest
Your mortgage amortization schedule outlines how much of each payment goes toward interest and how much goes toward principal.
In the early years of your mortgage, a larger portion of your payment goes toward interest. Over time, more of your payment goes toward the principal.
That’s why making extra payments—especially early on—can save you a significant amount of money. It reduces the principal faster, which means less interest over the life of your loan.
Prepayment Options and Interest Savings
Many lenders offer prepayment privileges, allowing you to make extra payments toward your principal without penalties. This can include lump sum payments or increasing your regular payment amount.
Using these options is one of the easiest ways to reduce the total interest you’ll pay and pay off your mortgage faster.
If you’re considering refinancing to take advantage of a better interest rate or lower your monthly payments, The Local Broker’s online application is a great place to start. It’s fast, secure, and easy to use.
What Impacts Your Mortgage Interest Rate?
Several factors influence the interest rate you’ll receive from a lender:
- Credit score: A higher score often qualifies you for a lower rate
- Down payment size: A larger down payment reduces your risk as a borrower
- Loan type: Fixed or variable rate, insured or uninsured
- Amortization period: Shorter amortizations may qualify for better rates
- Current market conditions: Interest rates fluctuate with the economy and central bank decisions
Mortgage brokers can help you compare rates from different lenders and find the one that best suits your situation.
Why It Matters
Even a small difference in interest rate can make a big impact on your total mortgage cost. For example, lowering your rate by just half a percent could save you tens of thousands of dollars over the life of your mortgage.
That’s why it’s important to understand how interest works and explore all your options before committing to a mortgage.
Final Thoughts
Understanding how mortgage interest works can help you make better financial decisions whether you’re buying your first home, refinancing, or renewing your current mortgage.
If you want help comparing rates, understanding your payment options, or figuring out how much interest you could save by refinancing, contact The Local Broker today. We’re here to help you find the right solution with honest advice and personalized service.
