How a home loan repayment works

Resources · Home loans and saving · 5 min read Building

Key points

• Each repayment covers that month’s interest first. Whatever is left reduces the balance.
• Early in a loan, most of each repayment is interest.
• As the balance falls, the interest share shrinks and the balance drops faster.
• Over a long loan, total interest can come close to the amount you borrowed.

The basic idea of a home loan repayment

Your home loan repayment is usually the same amount every time, paid over a long term, often running for decades. (Many countries call the loan a mortgage.) This kind of loan is called an amortising loan. The repayment is worked out so that if you pay it every month for the whole term, the balance hits exactly zero at the end.

Every month, two things happen:

1. Interest is charged on the balance you still owe.
2. Your repayment comes in. It pays that interest first, and the rest reduces the balance (the “principal”).

The repayment stays the same. But the split between interest and principal changes every single month.

A worked example

Here are the assumptions:

• Loan: $400,000
• Interest rate: 6% a year, charged monthly (0.5% a month)
• Term: 30 years (360 monthly repayments)
• Repayment: $2,398.21 a month (rounded up to the cent, with a final repayment of $2,390.59 because it only needs to clear what’s left)

The same maths works in any currency.

In month one, interest is 0.5% of $400,000, which is $2,000.00. Your repayment of $2,398.21 pays that interest, and only $398.21 goes towards the balance. You now owe $399,601.79.

Here’s how the split shifts over time:

Look at year 10. After a decade of repayments you still owe about $334,742. Less than a fifth of the loan is gone.

It gets more striking. Not until repayment 223, more than 18 years in, does the principal part of each repayment finally beat the interest part. And over the full 30 years you pay $463,347.98 in interest on top of the $400,000 borrowed. That’s $863,347.98 in total.

None of this means something’s wrong with the loan. It’s just how interest on a large balance behaves over a long time.

Why the early years feel slow

Interest is always worked out on what you owe right now. At the start you owe the most, so the interest charge is at its highest. The repayment is fixed, so a big interest charge leaves only a small amount to chip away at the balance.

Each month the balance drops a little. So next month’s interest is a little lower, and a little more of your repayment goes to principal. The effect builds slowly. Then it speeds up. In the last few years, almost the whole repayment is knocking down the balance.

That’s also why changes you make early in a loan have the biggest effect. Any money that cuts the balance early stops being charged interest for all the years that remain. Extra repayments on a home loan shows this with numbers.

What changes the numbers

The interest rate is the obvious one. On the example loan, each half a percentage point changes the monthly repayment by roughly $124 to $133 (between 5% and 7%). Over 30 years that adds up to tens of thousands.

The term matters too. A longer term gives you a lower monthly repayment but more total interest, because the balance stays high for longer. And then there’s the balance itself. A smaller deposit means a bigger loan, and every extra dollar you borrow attracts interest for the whole term.

Some loans also carry fees. In some countries there are interest-only periods, where the repayment covers only interest and the balance doesn’t fall at all. When one of those ends, repayments usually rise, because the full balance now has to be repaid over fewer years.

Weekly, fortnightly or monthly

Some loans let you choose how often you repay. If you just split the monthly amount into smaller, more frequent payments that add up to the same yearly total, the saving is usually small. It comes from the balance being reduced slightly sooner each month.

The bigger difference shows up when “fortnightly” means half the monthly amount every two weeks. There are 26 fortnights in a year, so that adds up to 13 monthly repayments instead of 12. That extra month’s worth is what shortens the loan. It’s the extra money doing most of the work, not the timing.

Common questions

Why is most of my home loan repayment interest?

Interest is charged on what you still owe, and at the start you owe the most. With a fixed repayment, a big interest charge leaves only a small amount to reduce the balance.

When do you start paying more principal than interest?

That depends on the rate and term. In the example above, a $400,000 loan at 6% over 30 years gets there at repayment 223, more than 18 years in.

Do fortnightly repayments pay off a home loan faster?

Splitting the monthly amount into smaller payments barely moves things. Paying half the monthly amount every two weeks is different. It adds up to 13 monthly repayments a year, and that extra money is what shortens the loan.

Try it

Want to see how your own loan splits between interest and principal, and what happens if you add a little more each month? Use the home loan extra repayments calculator. If you have other debts too, you can find your Freedom Date.

General information only, not financial advice. Your situation is your own.