Mortgage Principal And Interest: What’s The Difference?

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Mike Cetera is the editor in chief for Forbes Marketplace U.S. Mike has written and edited articles about mortgages, savings accounts, CD rates and credit cards for more than a decade. Prior to joining Marketplace, his work appeared on Bankrate, The Points Guy and Fit Small Business. Mike earned a master’s degree in public affairs reporting from the University of Illinois and has been a journalist for more than two decades. He also has offered his expertise in numerous TV, radio and print interviews.

Amy Fontinelle,

Amy FontinellePersonal Finance Expert

Mike Cetera

Mike CeteraEditor in Chief, Forbes Marketplace U.S.

Personal Finance Expert, Editor in Chief, Forbes Marketplace U.S.

Rachel WitkowskiCorrespondent/Editor

Rachel Witkowski is an award-winning journalist whose 20-year career spans a wide range of topics in finance, government regulation and congressional reporting. Ms. Witkowski has spent the last decade in Washington, D.C., reporting for publications including The Wall Street Journal, American Banker and Bankrate. Ms. Witkowski's deep knowledge of government and policy aided a series of investigative stories that triggered congressional hearings on employee claims of discrimination at a federal agency and how indirect auto lenders were being reviewed by regulators.

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Rachel Witkowski

Rachel WitkowskiCorrespondent/Editor

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Updated: Sep 28, 2020, 9:00am

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Mortgage Principal And Interest: What’s The Difference?

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Mortgage principal and interest are the two key parts of your monthly mortgage payment when you borrow money to buy a home. Your principal payment is what gets you out of debt. Your interest payment is what makes borrowing the money possible. Here’s a detailed breakdown of how mortgage interest and principal work and how they’re calculated.

What Is Mortgage Principal?

Mortgage principal is the sum you borrow from a lender to purchase a home. Part of each monthly payment you send in will go toward reducing your mortgage principal.

You might already be familiar with the concept of principal from another type of loan you’ve taken out. If you borrowed money to pay for college, that amount was your student loan principal. If you took out a loan to buy your car, the car’s price minus your down payment is your auto loan principal.

What Is Mortgage Interest?

Mortgage interest is the price you pay a lender to borrow the principal to purchase your home. Each month, part of your payment will go toward interest. Review your mortgage statements to see how much of your most recent payment went toward interest and how much went toward principal.

Most people claim the standard deduction on their income tax return. However, a small percentage of homeowners save more money by itemizing their deductions and claiming the mortgage interest deduction.

Mortgage interest on up to $750,000 in home loan debt is an expense you can itemize as long you incurred the debt to build, buy or substantially improve the home. Combining this expense with charitable donations and property taxes may get you over the standard deduction threshold, which is $12,200 for single filers and $24,400 for married filers in 2020.

Principal and Interest Example

Suppose you purchase a house that costs $250,000. You put down 20%, or $50,000. Your mortgage principal is the house price minus the down payment, or $200,000.

Let’s say you want to repay the $200,000 in principal over 30 years. To loan you this money, the lender needs an incentive—the opportunity to earn interest at a fixed rate of 3% per year for 30 years.

Using an online mortgage principal and interest calculator (also just called a mortgage calculator), you can see how much paying 3% interest on your loan balance over 30 years will cost you: $843 per month in principal and interest. Check out the calculator’s amortization schedule and scroll down to the payoff date. It will show that you’ll pay $103,601.28 in interest over 30 years to borrow $200,000 in principal.

Understanding Mortgage Amortization

Loan amortization is the parceling out of the principal and interest you owe over a predetermined period. In the case of a 30-year mortgage, that period is 360 months. If you get a 15-year mortgage, that period is 180 months.

Auto loans and student loans also amortize. Before you take out an amortized loan, you can use a calculator to see its amortization schedule. This schedule shows you exactly how much of your fixed monthly payment will go toward principal and interest each month.

How Do You Calculate Principal and Interest?

You can use a mortgage calculator to show you how much principal and interest you will pay over your mortgage term, and you can use an amortization calculator to see how much principal and interest you will pay each month. It can be helpful to know the math behind the calculator to understand where your money is going.

Your First Mortgage Payment

In month 1, you owe your lender $200,000, the full amount you borrowed. Your interest rate is 3% per year, which means it’s 0.0025% per month (3% divided by 12). Over the course of one month, you accumulate $500 in interest.

Interest accumulates over the course of the month, so when you make your first mortgage payment, you will have had your loan for at least a month. If you’ve had it longer—say, you closed your loan on the 15th—you will have prepaid a couple weeks’ interest as part of your mortgage closing costs.

So, you pay $500 in interest in month 1. We determined earlier that your monthly payment will be $843. Why this amount? It’s the amount the amortization math says you need to pay each month to retire your loan after making 360 payments. That means the remaining $343 of your first monthly payment will go toward paying down your mortgage principal.

Paying More Principal, Less Interest Over Time

In month 2, you owe your lender $199,657 (that’s $200,000 minus $343). At 0.0025% monthly interest, $499.14 of your next mortgage payment will go toward interest, and $343.86 will go toward principal.

And for each month going forward until you pay off your loan, two things will happen:

The amount of your payment that goes toward principal will increase slightly.
The amount of your payment that goes toward interest will decrease slightly.

As you pay down your mortgage principal, you have a smaller balance to accumulate interest. Since your monthly payment stays the same each month, the lender puts more of your payment toward principal because you don’t owe as much interest.

In this way, you’ll be able to pay down your mortgage steadily over 30 years. Your 359th payment will be allocated as $838.50 toward principal and $4.50 toward interest. Your 360th payment will be a bit larger, at $964.28, to kill off the remaining balance; $961.88 will go toward principal, and $2.40 will go toward interest.

How Taxes and Insurance Factor into Your Mortgage Payment

Property taxes and homeowners insurance might be included in your mortgage payment if your lender requires you to escrow these payments. Your lender might require a mortgage escrow account if you put down less than 20%, and it’s required if you get an FHA or USDA loan.

Let’s say your property taxes are $2,500 per year and your homeowners insurance is $1,000 per year. Your lender will divide each amount by 12 so that you pay your taxes and insurance gradually over the year.

The lender holds this money in your escrow account, then sends the money to your local tax collector and your insurer when the payments are due. Your monthly mortgage payment would be $1,134.67 after adding the $291.67 per month for taxes and insurance to your $843 principal and interest payment.

If you are required to pay for private mortgage insurance or flood insurance, your lender will escrow these amounts as well.

How to Pay off Your Mortgage Faster

You can pay off your mortgage faster by making additional principal payments. The key to making this strategy work is that you must specify that the extra money you’re sending in is a payment of additional principal. If you don’t, your mortgage servicer might apply it toward your next monthly payment, which won’t give you the result you’re looking for.

Do you get an annual bonus, have an irregular income or get a large tax refund? One way to pay off your mortgage faster is to make one extra payment per year when this extra income arrives. On a 30-year mortgage where you make one extra principal payment per year, you will pay off your mortgage about 3.5 years sooner. In our example of a $200,000 mortgage at 3% interest, you would save a little over $14,000 in interest by using this strategy to pay off your mortgage early.

Is your income steady throughout the year? In that case, you might want to pay additional principal with each monthly payment. You may be able to set up this arrangement through your servicer’s website so it happens automatically each month.