Mortgage Principal vs. Interest

If you’re trying to figure out how home loans work, you will need to master two essential terms: mortgage principal vs. interest. Understanding what these terms are, the roles that they play in determining how much you will pay for your home loan, and what you can do to influence them can have a major impact on the actual cost of your mortgage.

Both the mortgage principal and the interest need to be paid, but the reasons behind these obligations are quite different. As Forbes indicates, “Your principal payment is what gets you out of debt. Your interest payment is what makes borrowing the money possible.” Discovering both of their backstories and how they can impact your future is empowering. It gives you useful information you can use to make smart financial decisions regarding your home loan.

Terms to Know

In the matter of mortgage principal vs. interest, what do you need to know? Business Insider suggests starting with clear, user-friendly definitions of these two terms:

The mortgage principal is the amount that you borrow from a lender to purchase your home. You will repay it in regular monthly payments over the course of a set period in accordance with the terms that you agreed to in your home loan agreement.
The interest is what the lender charges for loaning you money. It is expressed as a percentage. You won’t need to make a second payment. The interest that you owe is combined with the mortgage principal as part of the monthly mortgage payment.

Amortization

When you’re talking about the relationship between mortgage principal and interest, there is a third item that is worth exploring: amortization. As Investopedia explains, a mortgage is a type of amortized loan because the debt is paid off on an amortization schedule that details how much of each payment goes to each component of the borrower’s loan. Early in the loan, the bulk of the payment will go toward the interest. A relatively small proportion will go toward the principal. While the required payment amount doesn’t change, the way that it is distributed does. As the loan matures, the balance shifts. Less of the payment goes to the interest, and more goes toward paying down the principal.

Should You Pay Mortgage Principal or Interest?

Your regular mortgage payment includes both mortgage principal and interest, and you’ll obviously want to be sure to pay it in full to meet your obligations and protect your credit. However, what if you have the funds to make extra payments? Should you put the money toward the principal or interest? As The Nest reports, making additional payments on your principal balance will actually shorten the life of your loan and decrease the amount of interest that you’ll owe. That means paying mortgage principal could help you own your home sooner and save you money on interest costs. Clearly, any extra funds should go toward the principal rather than interest.

Ways to Pay Off Your Mortgage Principal Faster

Paying down the mortgage principal faster can help you build equity and own your home free and clear sooner. Even small steps have the potential to produce welcome savings. However, be smart. First, check that your home loan doesn’t have a prepayment penalty. Then, be sure that all extra payments are marked as principal payments. If they aren’t, your lender may apply them as regular payments, which could dilute the benefit. There are a number of strategies that you can use to pay off your mortgage principal faster. Pick one or more that fits your needs, but before proceeding, verify that your payments will be processed properly. DoughRoller offers several ideas:

Make it a habit to pay a little extra each month.
Whenever you get a windfall, put it toward your principal balance.
If you receive a pay raise, put the difference on your mortgage.

Mortgage Principal vs. Interest