Definition
Interest Cost
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The interest cost of a home loan is a method of calculating the payments made by the borrower over a specified period time, relative to the amount of funds disbursed.
This is a time-adjusted formula that can measure the cost over any period of time, not just for the entirety of the loan.
It is also often referred to as the internal rate of return.
The formula to calculate interest cost is as follows:
L – U = P1 + P2/(1 + i)2 +. . . (Pn + Bn)/(1 + i)n, where
L = Loan amount
U = Upfront fees
P = Monthly payment
n = Month when full payment is made
Bn = Balance on month n
It takes into account the changes in interest rates which is a feature of floating rate mortgages.
All payments made by a borrower over the life of a loan would be accounted for.
This also means that while it is a more accurate measure of interest costs, it will also depend on assumptions when using it to work out future costs.
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