Mortgage Principal and Interest: What to Know

When you borrow to buy a home, you must pay back both principal and interest. The principal is the original amount you borrow, while interest is the cost of borrowing the principal.

The total amount of interest you pay, and the total cost of your loan are determined by your original principal balance, interest rate, and repayment timeline (commonly called your mortgage term).

What Does Principal and Interest Mean on a Mortgage?

Your monthly mortgage payment is based on the amount you must pay to cover your interest costs and reduce your principal balance by enough each month to pay your balance in full by the end of the loan term.

Initially, interest payments account for a larger portion of each principal and interest payment. But this changes over time.

Here are the details of both principal and interest.

• Principal: The principal is the total amount you borrow when you obtain your loan. When you buy a home, it usually equals the cost of the home, minus any down payment, plus any closing costs rolled into your loan.
• Interest: Interest is the cost you pay to borrow the principal. Your interest rate could remain the same over the life of the loan if you choose a mortgage with a fixed interest rate or could change over time if you get an adjustable-rate mortgage. Your interest rate helps determine your (APR). APR also includes fees and closing costs you pay to get a mortgage.

Your mortgage principal and interest payments only make up part of your payment if you also pay property tax and homeowners insurance costs to your lender each month.

What Other Factors Impact Home Loan Payments?

Principal and interest could account for your entire monthly mortgage payment, but for many people, it doesn't. Instead, most people with mortgages pay principal, interest, taxes, and insurance (PITI).

That's because many lenders require you to pay toward your property tax and homeowners insurance each month. Lenders put those tax and insurance payments into an escrow account, so the money is available to cover the bills when they are due.

The amount of your principal and interest payment is also determined by your mortgage term, typically whether you choose a 15-year or 30-year mortgage. A loan with a shorter repayment timeline will cost you less interest over time, but will have higher monthly payments.

If you choose a fixed-rate loan, your principal and interest payment will not change over the life of the loan. If you choose an adjustable-rate mortgage, your rate is tied to a financial index. It adjusts periodically, such as every six months or every year, and can move up or down depending on the index rate at the time of the adjustment.

How Does Principal and Interest Work on a Mortgage?

The best way to understand how your mortgage principal and interest payment works is to look at your mortgage amortization schedule.

Amortization is an accounting process that divides a loan into a series of equal, periodic payments. When you get a mortgage, you will have a mortgage amortization schedule that shows how your payment breaks down and what portion of each payment goes to principal and interest.

Over time, the distribution of your payment changes. As you pay down your balance, more of each payment goes to principal. But early on, most goes toward interest.

Why Do Early Mortgage Payments Go Mostly to Interest?

Early mortgage payments go mostly to interest because interest is calculated as a percentage of your balance. Having a larger balance means more interest is due each month.

Since a small percentage of each mortgage payment goes to reducing principal (even in the first few years of your mortgage), your balance declines each month. As interest is charged on the lower balance, the cost to cover the interest decreases, but your payment stays the same. The money no longer needed to cover interest goes to paying down more of your principal.

The chart below shows the difference between the amount of each payment that would go toward principal and interest over the life of the loan.

As explained above, each subsequent payment you make over the life of the loan pays a little more to principal and a little less to interest, because that interest rate is applied to a lower balance each month.

How Can You Calculate Mortgage Principal and Interest Payments?

Calculating your mortgage principal and interest payment can be complicated. You should use a mortgage calculator online or ask your lender to provide you with a calculation.

• Principal:To estimate what portion of your payment goes to principal, subtract your monthly interest charge from your total monthly principal-and-interest payment. For example, you would simply do the following math: [Monthly Payment]-[Monthly Interest]=[Monthly Principal Payment].
• Interest: You can estimate your monthly interest payment by multiplying your remaining loan balance by your annual interest rate, then dividing by 12. For a rough estimate, use this equation, [Remaining loan balance]*[Annual interest rate]/[12]=[Monthly interest].

Freedom Mortgage will always provide an exact breakdown of where your home loan payment is going.

How Can You Pay Down Your Loan Principal Faster?

If you want to pay off your mortgage early, you will need to pay your principal down faster than your amortization schedule.

The best way to do that is to make extra payments (beyond what is required each month). Each extra payment you make can reduce the principal directly, although you may need to specify to your lender that you want the payment applied this way.

If you reduce your balance faster, this changes your amortization schedule. Since your balance falls more quickly, this reduces the interest you owe each month. More of any subsequent payment will then go toward principal.

You can approach this in different ways. One option is to make a lump sum extra payment when you can, or to add an additional amount onto each payment, such as an extra $10 or $100. If your lender allows it, you could also make your mortgage payment biweekly, covering half with each paycheck.

Biweekly payments allow you to pay the equivalent of one full extra monthly payment each year. That extra payment can reduce principal more quickly, cutting years off your loan and saving you thousands in interest over the life of the loan.

Final Thoughts: Home Loan Principal and Interest Payments

It's important to understand how home loan principal and interest payments work so you can know where your money is going, understand when your mortgage will be repaid, and make informed choices on whether to make extra principal payments.

A mortgage professional at Freedom Mortgage can help you explore loan options and see how much principal and interest will cost on different loan types. Contact Freedom Mortgage today to learn more about saving money when you get a mortgage.