Buying a home is one of the biggest life decisions you’ll ever make. And for most people, this milestone comes with a mortgage. When you take out a mortgage to buy a home, your lender will charge you interest based on how much money you borrowed and the time it will take to pay it back.

Understanding interest is important to meet your financial goals—you could even save some money in the process. So let’s go over the basics of mortgage interest and how it works at ATB. 

How is mortgage interest calculated?

This might feel complex at first, but don’t worry. Mortgage interest is calculated based on four main factors:

• Your outstanding principal (the amount you borrowed) at the start of the calculation period
• Your interest rate
• The period of time you’re calculating interest for
• How often your interest compounds on the principal

So how do these actually impact what you pay in interest? Let’s break it down.

How is your interest rate determined?

When you finalize the details of your mortgage, you’ll agree on an interest rate. There are two main types of rates: fixed and variable. 

With a fixed-rate mortgage, your interest rate won't change for the term of your agreement. With a variable-rate mortgage, the rate changes according to your mortgage provider’s prime rate, meaning what you pay in interest can fluctuate.

Choosing between a fixed or variable rate depends on your unique financial situation. Your adviser will be able to help you determine what works best for you. 

How do mortgage payments work?

Every time you make a scheduled payment, part of the money will go towards paying off your principal and part will go towards interest. 

In the early years of your mortgage, more of your payments will go towards paying off interest. But as time goes on, more money will start to go towards your principal. This is because interest is calculated based on your outstanding principal. So the more of your mortgage you pay off, the less interest gets added to your payments.  

Want to pay less interest, or pay off your mortgage faster?

There are a few ways of doing this. The first is making a lump-sum payment towards your principal. This won’t pay off any current interest, but you’ll save on future interest by reducing your principal. Another great way is adjusting your payment schedule. You can choose whether you’d like to pay monthly, bi-weekly, weekly or semi-monthly. Your lender may also let you increase your payment amounts. The allowable increase percentage is usually 10/10, but it can be up to 20/20. Wondering what 10/10 looks like? The first 10 means you could pay a lump sum up to 10 per cent of the value of the original principal annually. The second 10 means you could increase your normal payments by up to 10%. Small changes today can lead to a big difference tomorrow. 

What is compound interest, and why does it matter?

Compounding interest is when the outstanding interest on your mortgage gets added to your principal. Basically, you’re paying interest on your interest. In Canada, lenders are legally required to compound interest at least every six months. So knowing how it works can help you make smart financial decisions. 

We want to help you stay on track and pay off your loan as scheduled. That’s why ATB calculates payments to ensure your principal never increases due to compound interest. 

How ATB calculates and compounds mortgage interest

At ATB, we calculate interest by rounding each month to 30 days, for a total of 360 days in the year. We do this mostly because it makes the math easier to understand for everyone involved. Plus, with this method, you get to save on five days of interest per year. 

While all lenders have to compound interest, ATB does it a little differently. We factor in compounding when we calculate your interest. This way, compounding happens at a consistent frequency so it never has to be added to your principal. The exact frequency depends on your specific mortgage. That said, it’s good to remember that things like payment deferrals can affect these calculations. 

Why we calculate interest this way

How does our approach benefit you? The idea is that if you make all your payments as planned, your principal won’t go up and down all the time. And you’ll enjoy a more manageable and predictable payment schedule.

Take a look at the chart below to see how compounding interest affects your principal at most banks. The increases or “spikes” in how much you owe happen when outstanding interest gets added back onto the principal on the compound date. 

Our method of calculating interest is designed to avoid sudden spikes. Instead, you’ll see a smooth, steady decline in your principal, as illustrated below. We do this so you can always see how much you owe without having to worry about interest spiking on compound dates—making repayment much easier.