Mortgage principal is the outstanding balance on a mortgage and is calculated as the total amount borrowed from a lender, less the amount you’ve repaid.
For example, suppose you obtain a $500,000 mortgage to purchase a home.
This amount represents your principal.
A portion of each mortgage payment you make is applied toward your principal, reducing the outstanding balance.
Did You Know?
Choosing an accelerated payment frequency could effectively add one extra monthly payment each year, allowing you to pay off your mortgage faster.
Mortgage Interest Explained
Mortgage interest is the amount your lender charges you to borrow money from them, to finance your home purchase.
It’s calculated as a percentage of your mortgage principal and can be fixed or variable.
Interest begins accruing on your mortgage the day you receive the funds from your lender.
Like the principal component, a portion of each mortgage payment you make covers the interest.
Let’s say that you secure a $500,000 mortgage at a 4.75% fixed interest rate, with a 25 year amortization and make monthly payments.
Your monthly payments will be around $2,837 and after a year you would have made payments of $34,047.
Out of that amount, $10,759 would be allocated to your principal and $23, 288 toward interest costs ($34,047 – $10,759).
Paying Down the Mortgage Principal
Paying down your mortgage principal is no easy feat.
It can take many years to pay down the balance, and you’ll pay a massive amount of interest along the way.
For this reason, it’s wise to secure the lowest possible interest rate you can.
Suppose you acquire a mortgage for $370,500 with the following attributes:
- 25-year amortization period
- 5% interest rate
- Five-year fixed-rate term
- Monthly payments
The table below illustrates how much you can expect to pay in interest each year relative to the principal.
| Year | Ending Balance | Total Payments | Principal Portion | Interest Portion | Interest as % of total payments |
|---|---|---|---|---|---|
| 1 | $362,804 | $25,858 | $7,696 | $18,162 | 70.24% |
| 2 | $354,718 | $25,858 | $8,086 | $17,772 | 68.73% |
| 3 | $346,223 | $25,858 | $8,495 | $17,363 | 67.15% |
| 4 | $337,298 | $25,858 | $8,925 | $16,933 | 65.48% |
| 5 | $327,921 | $25,858 | $9,377 | $16,481 | 63.74% |
As you can see, a considerable portion of your payments go towards settling the interest on your outstanding balance.
Nearly half of your total costs during early years of the term consist of interest charges.
Your total interest expense for the term is $86,711 or 23.40% of your initial mortgage principal of $370,500.
Below are scenarios that show the difference in interest costs you can expect with a higher and lower interest rate, respectively.
6% interest rate
| Year | Ending Balance | Total Payments | Principal Portion | Interest Portion | Interest as % of total payments |
|---|---|---|---|---|---|
| 1 | $363,832 | $28,446 | $6,668 | $21,778 | 76.56% |
| 2 | $356,758 | $28,446 | $7,074 | $21,372 | 75.13% |
| 3 | $349,253 | $28,446 | $7,505 | $20,941 | 73.62% |
| 4 | $341,292 | $28,446 | $7,962 | $20,484 | 72.01% |
| 5 | $332,845 | $28,446 | $8,447 | $19,999 | 70.31% |
4% interest rate
| Year | Ending Balance | Total Payments | Principal Portion | Interest Portion | Interest as % of total payments |
|---|---|---|---|---|---|
| 1 | $361,651 | $23,387 | $8,849 | $14,538 | 62.16% |
| 2 | $352,445 | $23,387 | $9,206 | $14,181 | 60.64% |
| 3 | $342,867 | $23,387 | $9,578 | $13,809 | 59.05% |
| 4 | $332,902 | $23,387 | $9,965 | $13,422 | 57.39% |
| 5 | $322,534 | $23,387 | $10,368 | $13,019 | 55.67% |
With a 6% interest rate, you’d pay $104,574 in interest over your term’s duration and finishing a five-year term with a higher mortgage principal than if your interest rate was 5%.
Conversely, with a 4% interest rate, your total interest expense would amount to $68,969, and you’d end your term with a smaller principal balance.
Regardless of the rate, what should be evident from these figures is that the percentage of each mortgage payment applied to interest is highest at the loan’s inception and gradually dwindles each year.
The reason is that the principal balance is the largest at the beginning, and payments are distributed over a lengthier period, which allows more interest to accumulate.
As your principal shrinks over time, a higher percentage of each payment goes towards paying down the principal.
To help borrowers pay down their mortgage faster, many lenders include a prepayment provision in mortgage contracts they issue.
A prepayment is a lump sum amount of money you can pay toward your mortgage in addition to your regular payments.
Your lender will apply the prepayment directly against your existing principal.
By routinely contributing a prepayment (say once per year), you can shorten the length of your mortgage substantially and save immensely on interest costs.
Fact
If you have an open mortgage, you can contribute a prepayment as often as you like, for any amount you wish without incurring a penalty.
