Mortgages use simple daily interest, not compound interest. Interest is calculated on your principal balance each day based on your annual rate divided by 365. If you pay on time, the interest never compounds.
However, amortization means that your early payments are mostly interest and very little principal. Over a 30-year loan, you pay a significant amount in total interest.
On a $300,000 loan at 6.5%, you will pay roughly $384,000 in total interest over 30 years, which is more than the principal itself. Understanding how interest works helps you make smart decisions about extra payments and loan terms.
Simple vs Compound Interest
With simple interest, you only pay interest on the principal balance. With compound interest, you pay interest on your interest. Mortgages in the US use simple daily interest, meaning unpaid interest does not add to the principal (unless you go into default). Credit cards and some other loans use compound interest.
How Amortization Works
Your monthly payment stays the same for a fixed-rate mortgage, but the split between interest and principal changes over time. In year one, about 80% of your payment goes to interest. By year 20, most of your payment goes to principal. This is called amortization, and it is why you build equity slowly at first.
Total Interest Over the Loan Term
On a $300,000 loan at 6.5% for 30 years: monthly payment $1,897, total payments $682,972, total interest $382,972. At 7%: monthly payment $1,995, total interest $418,328. At 5%: monthly payment $1,610, total interest $279,767. The rate makes a huge difference in total interest paid.
Effect of Extra Payments
Adding $100 per month to your payment on that $300K loan at 6.5% saves you about $91,000 in interest and pays off the loan 6 years early. Adding $200 per month saves $145,000 in interest and pays off the loan 9 years early. Extra payments reduce the principal faster, which reduces future interest.
Visualization of Interest Over Time
In year 1, of your $1,897 payment, approximately $1,625 goes to interest and only $272 to principal. By year 15, the split is approximately $1,400 interest and $497 principal. By year 25, it flips to approximately $800 interest and $1,097 principal. The total interest curve is steepest in the first half of the loan.