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What is mortgage principal and how does it work?

Published May 29, 2024| minute read

    Your mortgage principal is the original sum of money you borrowed to purchase your home. You could say it’s the bedrock of your loan agreement and one of the larger factors in determining your monthly payments. Understanding your mortgage principal may even highlight ways to optimize your mortgage. Let’s look at the ins and outs of your mortgage principal, how to calculate it and instances where it might change.

    What is principal in mortgage?

    Your mortgage principal is essentially the base loan amount of your mortgage. For instance, if you’re looking to purchase a home that was appraised at $400,000 with a down payment of $80,000 (so, 20%), your mortgage would be for the remaining $320,000. That $320,000 is your mortgage principal.

    It’s important to note that the mortgage principal is not the sum of all the money you owe for the house — just the initial loan value you borrowed. As you make payments, a portion of each payment reduces your outstanding principal. However, not every dollar goes towards the principal. This is where interest comes in.

    Principal vs. interest

    So, how do principal and interest they relate? If the mortgage principal is the money you borrowed to buy your house, the mortgage interest is the amount you pay for borrowing. Interest is how lenders make money. Initially, in many mortgage structures, a larger chunk of your monthly payment goes directly toward interest. As the loan matures, however, a larger portion goes toward mortgage principal payments. This is because interest is generally charged as a percentage of the remaining mortgage principal. As you make routine payments that lower your principal, the interest charged on that principal also reduces. This process is called amortization, and you can use online tools like the amortization calculator to outline how your payments will shift toward paying more and more of the mortgage principal over time.

    Paying attention to the difference between the principal vs. interest on your mortgage can help you make more informed decisions and potentially identify ways to optimize your mortgage. For example, this information may help you figure out when it might make sense to refinance or how extra mortgage payments factor into your loan’s lifespan.

    How to calculate mortgage principal and interest

    Here’s how to calculate your mortgage principal and the interest so you can stay informed about your home loan:

    How to calculate mortgage principal

    To determine your currently outstanding mortgage principal, start with the total loan amount you borrowed. Next, add up all the portions of payments that have gone directly to the principal before subtracting the result from your original borrowed principal. You can typically check your mortgage statement for the amount paid toward your principal or refer to your home loan’s amortization schedule. Typically, both resources provide a clear breakdown of the principal vs. interest for each payment.

    For example, returning to our hypothetical purchase from above, you’d start with the total borrowed — $320,000. If your mortgage statement shows that you’ve currently paid $15,000 toward the principal, your current mortgage principal balance would be $305,000.

    How to calculate interest

    Interest is calculated based on the amount of the mortgage principal that remains unpaid. To find out the size of your next scheduled monthly interest payment, take the outstanding principal amount, multiply it by the annual interest rate of 4% and then divide it by the number of times you make a payment in a year (often 12 for monthly payments).

    Let’s say, for example, that your annual interest rate is an even 4%. If your current outstanding mortgage principal is $305,000, your annual interest payment would be $12,200 and your next monthly payment would be $1,016.67 (the annual interest amount divided by 12). The calculation would look something like this:

    $305,000 x 0.04 = $12,200

    $12,000 / 12 = $1,016.67

    Other costs that may be included in your monthly payments

    Your monthly mortgage payment may also include other costs. Homeowner’s insurance, which covers potential damage to your property, and property taxes are common additions. Some lenders may set up an escrow account to bundle these additional costs and help ensure timely payments. If your down payment was below a certain percentage, you might also be paying private mortgage insurance (PMI).

    Do note that escrow payments can fluctuate depending on county, city or township tax collectors and insurance carriers. Consumers are notified by their lender of any adjustments ahead of time.

    Could your principal or interest ever change?

    Certain circumstances and decisions can alter both your principal and interest over the lifetime of your loan. Let’s examine a few situations in which either component might change:

    Adjustable-rate mortgage

    An adjustable-rate mortgage (ARM) is a type of loan where the interest rate may change over time. Unlike fixed-rate mortgages, which keep a constant interest rate throughout your mortgage term, ARMs have rates tied to a specific financial index. This means that if the index rises or falls, your interest rate — and thus the interest component of your monthly payment — adjusts accordingly.

    Mortgage amortization

    Your mortgage amortization refers to the process of how your mortgage principal and interest get paid off over time. Making extra payments, beyond your regular monthly payment, can help reduce your mortgage principal faster than initially planned according to the schedule. This also helps reduce the total interest you’d pay over the lifetime of the loan, since there’s less principal left for interest to accrue on.

    Mortgage refinancing

    Refinancing involves replacing your existing mortgage with a new one, often with a different interest rate or loan term. Homeowners might refinance to take advantage of lower interest rates, change the duration of their loan or switch from an adjustable-rate to a fixed-rate mortgage (or vice-versa). Refinancing might alter both the principal (if you cash out some equity) and the interest rate.

    Mortgage modification

    A mortgage modification is an agreement between lender and borrower to make changes to one or more terms of a mortgage. This could be for a variety of reasons, such as financial hardship or other factors that make the original loan terms challenging for the borrower. Changes could include alterations to the interest rate or the total outstanding principal.

    In summary

    Your mortgage principal is the amount you borrowed to buy your home. Keeping your mortgage principal in mind alongside your interest charges can help you stay informed about the state of your mortgage and potentially highlight ways to optimize your repayment plan. Speak with your lender to help clarify any confusion surrounding the terms and conditions of your mortgage.

    Mortgage principal FAQs

    1. How do you find the principal of a mortgage?

    You can typically find your mortgage principal in your mortgage agreement or statement. To calculate your current outstanding principal yourself, subtract the sum of all your payments made toward the principal (without interest) from your original loan amount.

    2. Why is my interest higher than my principal?

    At the beginning of a mortgage, a larger portion of your payment may go toward interest rather than reducing the principal. This is because the interest is calculated based on the remaining principal balance, which is highest at the start. As you make more payments and the principal decreases, the interest portion shrinks, and a greater portion of your payment goes toward repaying the remaining principal.

    3. What happens when you pay extra principal on mortgage?

    When you pay extra toward the principal of your mortgage, you reduce the outstanding loan balance more quickly. This can result in paying off your mortgage sooner and saving money on interest over the life of the loan. Each extra payment typically lowers the principal directly, which in turn reduces the amount of interest you pay in the future.

    4. What percentage of a mortgage payment goes to principal?

    The percentage of a mortgage payment that goes to principal varies over the life of the loan. In the early years, a smaller percentage goes to the principal while a larger portion covers the interest. As the principal balance reduces, a larger percentage of each payment goes toward the principal. The exact percentage can be found on an amortization schedule which outlines how each payment is split between interest and principal throughout the life of the mortgage. You can request an amortization schedule from your servicer or you can find amortization tools online.

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