Mortgage Tools
Finding the Formula to Calculate Mortgage Payments
The formula to calculate mortgage payments is a complex one and can be very challenging for most homeowners to understand.
We at CMI believe that it is in your best interest to understand this formula and how it affects your overall cost of borrowing. The explanation below will help improve your understanding of this complex calculation.
Calculating a Mortgage Payment
A loan taken out with monthly payments at an annual rate of interest of 6% would be calculated as 6%/12, for a monthly rate of 0.5%. Calculating a mortgage rate is relatively straightforward and easily understood by most people.
For standard loans, this formula works fine, but mortgages are another story entirely. The main reason for the complexity is that mortgages have compound interest Compound interest is, essentially, interest paid on interest.
Consider that when you take out a mortgage, the repayment follows an amortization schedule. Interest begins accruing immediately. To calculate your monthly payment, the lender multiplies the monthly interest rate by the outstanding balance. The lender will calculate and deduct the interest from the payment first, and then apply the remainder to the principal. This means that more of your initial payments go to interest than the principal, so even though you are making monthly payments, interest is still increasing.
It is only after many years that the pendulum swings and you begin to make a dent in the actual principal.
To add another wrinkle into the formula, by law, all fixed-rate mortgages in Canada are compounded semi-annually. According to Alan Marshall at Toronto's York University:
"...if you are quoted a rate of 6% on a mortgage, the mortgage will actually have an effective annual rate of 6.09%, based on 3% semi-annually. However, you make your interest payments monthly, so your mortgage lender needs to use a monthly rate based on an annual rate that is less than 6%. Why? Because this rate will get compounded monthly."
Is it any wonder Canadians find mortgage rates confusing?
Fortunately, CMI has made it easier for you. We have included on this website a mortgage calculator that allows you to plug in a few simple numbers to see what your mortgage payments would be in different scenarios.
Simply enter the loan amount, the interest rate, the amortization period and the payment frequency and then click Calculate. With this easy-to-use calculator, you can quickly compare interest rates and see the difference between monthly and biweekly payments.
Consult with CMI Experts about Mortgage Rates
Sound financial planning means knowing all of the options available to you. Combining our formula to calculate mortgage payments with a CMI broker consultation can help you decide on the best option for your unique financial situation.
