Calculate Mortgage Payments: The Bank Formula Explained

Banks and mortgage calculators compute your monthly payments based on the annual interest rate, the period of the loan, and the principal. The formula they use is based on something called the "time value of money theory," which means many things to lending institutions, but only one thing to a borrower: interest. Using the steps below you can be your own mortgage calculator and compute your monthly payments with accuracy.

Step 1

Divide the annual interest rate by 12 and call this new number capital 'R.' For example, if you have a 6% rate, then R = .06/12 = .005. Multiply the number of years by 12 the find the number of months in the loan period, and call this number capital 'Y.' For example, if you have a 30 year mortgage, Y = 360.

Step 2

Compute the number (1+R)^Y and call this number 'W.' For example, (1+.005)^360 = 6.0226, so W = 6.0226. Make sure you keep at least 4 digits behind the decimal point. If you round off too much, you will get an inaccurate final answer.

Step 3

Compute the number (R x P x W)/(W - 1), where P is the principal of the loan, i.e., the amount borrowed. For example, if the principal is $100,000, you would get (.005x100000x6.0226)/(6.0226-1) = 3011.3/5.0226 = 599.55

Step 4

The number 599.55 is your monthly payment. So every month, you would pay $599.55 for 30 years. Notice that if you multiply $599.55 by 360 you get $215,838. So even though the loan amount was $100,000, you actually pay more than double over the course of the loan period. That extra money is the total interest.

Things You'll Need

• Principal of the loan 'P'

• Annual interest rate 'r'

• Number of years 'y'

• Calculator