In real estate, “interest” refers to a legally recognized stake, claim, or right that a person or entity holds in a property. It includes:
Borrowers incur financial interest as the cost of a loan, while lenders hold security interest to protect their investment. Investors evaluate ownership and lien interests to assess risk, control, and potential returns.
Simple interest is calculated only on the principal balance. Compound interest accrues on both principal and previously accrued interest, though most mortgages use simple interest applied periodically.
Daily accrual methods (Actual/360, Actual/365) calculate interest each day. Monthly accrual divides the annual rate by 12. The chosen method affects total interest paid.
The basic interest formula is Interest = Principal × Annual Rate × Time. Lenders adjust “Time” to match accrual conventions (days/360, days/365, or monthly periods).
APR reflects the true cost of borrowing, expressed as an annual rate including interest and certain fees.
Origination fees, discount points, and mortgage insurance premiums are factored into APR, raising it above the nominal interest rate.
APR standardizes different loan costs, enabling apples-to-apples comparison between lenders and loan products.
A fixed-rate mortgage locks the interest rate for the loan term, offering predictable payments and protection against market rate increases.
ARMs start with a lower introductory rate that adjusts periodically based on an index plus a margin. Pros: lower initial rate. Cons: payment uncertainty if rates rise.
Hybrid ARMs combine a fixed period (e.g., 5 years) with subsequent adjustments. Interest-only loans allow principal deferral for a set period, reducing early payments but increasing long-term costs.
Monthly P&I payment uses the amortization formula: M = P [r(1+r)^n] / [(1+r)^n–1], where P is principal, r monthly rate, and n number of payments.
Total interest = (Monthly Payment × Total Payments) – Principal. Longer terms yield higher total interest despite lower monthly payments.
Shorter terms have higher monthly payments but significantly lower total interest. A 15-year loan can save tens of thousands in interest versus a 30-year loan.
Higher credit scores and clean histories qualify you for lower rates. Dings and late payments raise your rate.
A larger down payment lowers LTV, reducing lender risk and often unlocking better rates and avoiding PMI.
Conforming vs. jumbo loans, term length, and macroeconomic factors (Fed policy, inflation) all influence rate offerings.
Pay down high-interest debt, dispute errors, and maintain low credit utilization before applying.
A down payment of 20% or more reduces LTV and can qualify you for premium rates.
Rate locks protect you from rate hikes during underwriting. Compare multiple lenders before locking.
Paying points upfront can lower your rate. Mortgage brokers may have access to exclusive wholesale rates.
Early payments are interest-heavy; later payments shift toward principal.
Even small additional payments reduce the balance, cutting interest accrual and shortening the term.
Bi-weekly payments, lump-sum contributions, and refinancing to a shorter term accelerate payoff and save interest.
Use APR and total cost disclosures to compare loans rather than advertised rates alone.
Enter fees, points, and insurance separately. Verify settings for daily vs. monthly accrual.
Unusually low rates may hide high fees, balloon payments, or prepayment penalties.
Primary and secondary homeowners can deduct interest on mortgages up to $750,000 (for loans closed after 2017).
Lenders issue Form 1098 showing deductible interest. Keep accurate records for tax filing.
High earners may face phase-outs. Under AMT, state and local deductions are limited, but mortgage interest generally remains deductible.
Buyer “Sarah” purchases a $300,000 home with 20% down ($60,000) and finances $240,000 at a 3.5% fixed 30-year rate. Her monthly P&I payment is ≈ $1,078. In year one, ≈ $6,850 goes to interest, the rest to principal.
Investor “Mark” refinances a $200,000 rental from 5.2% to 4.0% on a 30-year term. His payment drops from ≈ $1,107 to ≈ $955, saving $152/month or $1,824/year.
Interest defines legal rights and borrowing costs. Understanding rate types, APR, and amortization helps you make informed decisions and minimize costs.
What is the APR vs. the nominal rate? Which accrual method applies? Are there prepayment penalties or points?
Use online mortgage calculators, visit our glossary, and check lender FAQs to deepen your understanding.
