By James Gregors

When people ask how are mortgage repayments calculated, they’re usually trying to understand how their home loan repayments are worked out each month and why that repayment amount can change over time.

These figures will impact so much of your life, and a mortgage broker at The Property Education Company will explain how mortgage repayments are calculated based on the outstanding loan balance, interest rate and loan term. All the brokers have a focus on education, so our home buyer clients feel more confident about their decisions.

If you’re just beginning your home-buyer journey, this article will help you get clear on how mortgage repayments are calculated and how much you can expect to pay each month.

In short: How are mortgage payments calculated?

• Mortgage repayments are calculated using your loan amount, interest rate, loan term and loan type (such as principal and interest or interest only).
• Interest is calculated daily on the outstanding loan balance and charged monthly, which is why early repayments are more interest-heavy.
• Principal and interest repayments gradually reduce the loan balance, while interest-only repayments do not.
• Interest rate changes, repayment frequency and extra repayments all affect how much interest you pay over the life of the loan.
• Offset accounts and additional repayments can significantly reduce interest and help you pay your home loan sooner.
  

When you have read this article, you can try our repayment calculator for a general idea of your mortgage repayments, or contact us for a personalised answer and an estimate of your borrowing power.

How are mortgage payments calculated?

At a basic level, mortgage repayments are calculated using four key inputs:

• Your loan amount (also called the principal loan amount or principal amount)
• Your interest rate (fixed or variable)
• Your loan term (for example, 25 or 30 years)
• Your loan type (such as a principal and interest loan or an interest-only home loan)
  

Most Australian lenders calculate home loan repayments by applying interest to your loan balance daily, then charging that interest to your home loan account or mortgage account monthly. According to The Property Education Company, understanding this daily interest calculation is one of the most important concepts for first home buyers trying to estimate their true repayment costs.

Principal and interest repayments explained

The most common structure for an owner-occupied home loan (where you live in the house while paying it off) is a principal-and-interest loan.

With principal and interest repayments, each repayment is split into:

• Interest repayments, which cover the cost of borrowing
• A principal repayment, which reduces the loan so you are gradually paying off the amount you owe, and on your way to total home ownership (the ultimate dream)
  

Early in the loan, your monthly mortgage repayments don’t look like they are making much of a difference to your outstanding amount. This is because the loan balance is higher, so more interest is calculated. Over time, as the home loan balance reduces, a greater portion of each repayment is applied to reducing the principal amount.

Borrowers often feel they’re paying “mostly interest” at the start. This is normal and built into how repayments are structured. The Property Education Company regularly sees first home buyers worry about this early repayment structure, even though it is a normal and expected part of a principal and interest home loan.

The tip? Make extra repayments if you can. This will help you pay off your loan sooner.

How interest is calculated on a home loan

Interest on a home loan is calculated daily using the outstanding loan balance:

Loan balance × interest rate ÷ 365

That daily interest is then added up and charged to your mortgage account at the end of each month. This is why:

• Making extra repayments early can significantly reduce interest
• Holding funds in an offset account lowers how much interest you pay
• Even small additional repayments can help pay the loan sooner
  

The higher your interest rate, the more interest charges accrue, which is why rate changes have a direct impact on repayment amount.

Fixed rate vs variable rate vs split rate home loan repayments

Now you need to understand more about interest rates and your options.

Variable rate home loan

With a variable rate loan, your variable interest rate can move up or down based on market conditions and decisions by the Reserve Bank and your lender. This means:

• Your monthly payments can change
• Your estimated repayment amount may increase or decrease
• You usually have flexibility to make extra repayments
  

Usually, if the Reserve Bank changes the official cash rate, banks and lenders make an announcement about changing their rates within a few days, then apply it to variable loans (you’ll get a letter in the mail about it).

When interest rates were dropped to record lows during COVID, borrowers on variable rates enjoyed far lower minimum repayments. However, when rates rose sharply again, people weren’t so happy! Some found a workaround by ‘locking in’ a fixed rate for a set period. This is always something to discuss with your mortgage broker.

Fixed-rate loan

With a fixed-rate loan, your interest rate is locked in for a fixed period (for example, two or three years). During that time:

• Monthly mortgage repayments stay the same regardless of Reserve Bank decisions
• Extra repayment limits may apply
• Your repayment certainty is higher
  

Both loan options use the same repayment formula, only the interest rate applied is different.

Fixing a loan makes sense when rates are low and tipped to go up, but you still need to review your options before you commit.

Split loans

A split loan is a home loan structure where your total loan amount is divided into two parts, usually with one portion on a fixed interest rate and the other on a variable interest rate. Both parts sit under the same home loan, but each portion has its own interest rate, repayment amount and rules. This allows you to spread your risk rather than committing the entire loan to one rate type.

In practice, a split loan gives you a balance between certainty and flexibility. The fixed portion provides stable repayments for a set period, which can help with budgeting, while the variable portion allows flexibility such as making extra repayments or using an offset account. Your total mortgage repayment is simply the combined repayments of each split.

A split loan may suit you if you want some protection against interest rate rises without locking in your entire loan. However, it’s not ideal for everyone, so again, getting personal advice is essential.

Need help to structure your home loan?

We’ll explain potential repayment costs and outline a strategy with you.

Book a first home buyer strategy call here.

Interest-only loans and interest-only periods

Some borrowers choose an interest-only loan or an interest-only home loan, particularly for an investment property.

During the interest only period (also called the only period):

• Your repayments cover interest only
• You pay interest, but the loan principal/amount of the loan does not reduce
• Your loan balance remains unchanged
  

Once the interest only period ends, repayments usually increase because the remaining principal loan must be repaid over a shorter loan term. This is a strategy more commonly applied when investing, and again, you need to work with a broker or financial planner or accountant to check if it makes sense for you.

How repayment frequency changes your home loan

Most loan repayments are set as monthly mortgage repayments, but changing repayment frequency can reduce total interest.

For example:

• Monthly repayments = 12 payments per year (equivalent to 24 fortnightly repayments)
• Fortnightly repayments = 26 payments per year
  

The extra repayments each year help:

• Reduce the loan principal faster
• Lower total interest charges
• Pay the loan sooner

Using calculators to estimate repayments

A repayment calculator, mortgage calculator or home loan repayment calculator estimates repayments based on:

• Loan amount
• Interest rate
• Loan term
  

These tools provide an estimated repayment, but they don’t fully account for additional costs and factors such as:

• Offset account balances
• Interest-only periods
• Lenders mortgage insurance
• Comparison rates
• Individual home loan features
• Your personal circumstances
  

Estimated repayments based on calculators should be treated as a guide only, but they are a good place to start! You can find our repayment calculator here.

What lenders look at when approving home loan applications

When assessing loan approval and credit approval, lenders don’t just look at your estimated repayment.

They also consider:

• Your borrowing power
• Your home loan details
• Eligibility criteria
• Minimum deposit requirements
• Property value and security property (if relevant)
• Your capacity to meet minimum repayments
• Whether lenders mortgage insurance applies
  

Importantly, lenders assess repayments at a higher interest rate than your actual rate to ensure affordability if rates increase. This is known as a ‘buffer.

Read more: How much can I borrow for a home loan?

Mortgage payment example

Let’s break this down with some nice round numbers. This is just an example and factors could change it, but it gives you an idea.

Loan Details

• Loan amount: $1,000,000
• Interest rate: 5.00% per annum
• Loan term: 25 years
• Loan type: Principal and interest
• Repayment frequency: Monthly

Step 1: Understand what the repayment includes

Each monthly repayment includes:

• Interest, calculated daily on the outstanding loan balance
• Principal, which reduces the loan over time

Because this is a principal and interest loan, the repayment amount stays broadly consistent, but the split between interest and principal changes over time.

Step 2: Calculate the monthly repayment

On a $1 million loan at 5% interest over 25 years, the monthly mortgage repayment is approximately:

$5,845 per month

This amount is calculated so the loan balance reaches zero at the end of the 25-year loan term.

Step 3: How that repayment looks in year one

In the first year:

• A larger portion of the $5,845 monthly payment goes toward interest
• A smaller portion goes toward reducing the loan principal
  

For example, in the first month:

• Interest charged ≈ $4,167
• Principal repaid ≈ $1,678

This is why borrowers often feel they are mostly paying interest early on.

Step 4: How home loan repayments change over time

As the loan balance reduces:

• Monthly interest charges decrease
• Monthly principal repayments increase
• The total repayment stays roughly the same (depending on interest rates)
  

By the final years of the loan:

• Most of each repayment goes toward principal
• Interest makes up a much smaller portion
  

Step 5: What changes the repayment amount?

Your repayment amount would change if:

• The official interest rate increased or decreased and you are paying variable rates, or you switch to a fixed rate
• The loan term was shorter or longer
• You switched to an interest-only period
• You made extra regular or lump sum repayments or used an offset account
  

For example:

• A higher interest rate = higher monthly repayments
• A longer loan term = lower repayments but more interest overall

Want to know how much your mortgage repayments will be?

The Property Education Company specialises in helping first home buyers figure out their mortgage payment costs by breaking down the numbers and explaining each option in detail.

For first home buyers who want to borrow the maximum amount possible without stretching their budget beyond their limits, working with a broker who focuses on education rather than transactions can make the process clearer and less stressful. It’s all about knowledge and preparation… and that’s what we focus on.

Home Loan Repayment FAQs

How are mortgage repayments calculated each month?

Mortgage repayments are calculated based on your loan amount, interest rate, loan term and loan type. Lenders calculate interest daily on your loan balance and apply it to your mortgage account monthly.

Why do my home loan repayments feel like they’re mostly interest?

In the early years of a home loan, the loan balance is higher, so more interest is calculated. Over time, as the principal reduces, a greater portion of each repayment goes toward paying down the loan.

What’s the difference between principal and interest and interest-only repayments?

With principal and interest repayments, you pay interest and reduce the loan balance.

With interest-only repayments, you only pay interest for a set period, meaning the loan balance does not decrease and you only profit from the property’s growth in value.

Do extra home loan repayments really reduce how much interest I pay?

Yes. Extra repayments reduce the loan principal, which lowers daily interest calculations and can save a significant amount of interest over the life of the loan.

How accurate is a home loan repayment calculator?

A home loan repayment calculator provides an estimated repayment amount only. It doesn’t factor in offset accounts, interest-only periods, lender fees, comparison rates or your personal circumstances. You can try our repayment calculator here.

How do interest rate changes affect my repayments?

On a variable rate home loan, changes to the interest rate (often influenced by the Reserve Bank) will increase or decrease your monthly mortgage repayments. Fixed rate loans remain the same during the fixed period.

Does changing repayment frequency make a difference to my mortgage?

Yes. Switching from monthly to fortnightly or weekly repayments can reduce interest because you make repayments more frequently and effectively make an extra repayment each year.

Why do lenders assess repayments higher than what I actually pay?

Lenders use a buffered interest rate when assessing loan approval to ensure you can afford repayments if interest rates rise in the future.

How does The Property Education Company help first home buyers understand repayments?

The Property Education Company focuses on breaking down how mortgage repayments are calculated, helping first home buyers understand interest, loan structure and repayment strategies before committing to a loan.

Want to know what your mortgage payments will look like? Call 0468 026 200 or connect with an experienced mortgage broker here.

About the author:

As an MFAA-certified finance broker, James Gregors has been helping first home buyers and other investors to build their property portfolio for many years. He is especially dedicated to helping first time buyers experience the excitement of buying their first home.

James loves learning about property opportunities then sharing what he has learnt with his clients. He has a natural flair for figures, which makes him a whiz at working out the most advantageous borrowing opportunities.

Disclaimer: This advice is general in nature. Your full financial situation would need to be reviewed prior to acceptance of any offer or product.

Licensing Statement: Credit Representative 365124) is authorised under Australian Credit Licence 389328.