What is Mortgage Principal?

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 2.5% fixed interest rate, with a 25 year amortization and make monthly payments. 

Your monthly payments will be around $2,240 and after a year you would have made payments of $26,878.

Out of that amount, about $14,608 would be allocated to your principal, with the remaining $12,270 ($26,878 – $14,608) being paid in interest costs.

Couple discussing mortgages with broker

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
  • 3% 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 $360,368 $21,040 $10,132 $10,908 51.84%
2 $349,930 $21,040 $10,438 $10,602 50.39%
3 $339,177 $21,040 $10,753 $10,287 48.90%
4 $328,098 $21,040 $11,079 $9,961 47.34%
5 $316,684 $21,040 $11,414 $9,626 45.75%

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 $51,384 or 13.87% 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.

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 55.68%

2% interest rate

Year Ending Balance Total Payments Principal Portion  Interest Portion Interest as % of total payments
1 $358,948 $18,827 $11,552 $7,275 38.64%
2 $347,163 $18,827 $11,785 $7,042 37.40%
3 $335,141 $18,827 $12,022 $6,805 36.14%
4 $322,877 $18,827 $12,264 $6,563 34.86%
5 $310,367 $18,827 $12,510 $6,317 33.55%

With a 4% interest rate, you’d pay $68,969 in interest over your term’s duration and finishing a five-year term with a higher mortgage principal than if your interest rate was 3%. 

Conversely, with a 2% interest rate, your total interest expense would amount to $34,002, 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. 

Frequently Asked Questions

  • Is it better to pay the principal or interest?
  • What happens when you pay off principal on your mortgage?
  • Is it better to make principal-only payments?

Mark is a freelance writer who specializes in covering personal finance topics related to investing, mortgages, credit cards, and more.

He is passionate about educating people on how the financial markets work and providing tips to help them better manage their money. Mark holds a bachelor’s degree in finance from the Northern Alberta Institute of Technology and has more than a decade of experience as an accountant.

Outside of writing and finance, he enjoys playing poker, going to the gym, composing music, and learning about digital marketing.