What is Mortgage Principal?

By: Mark Gregorski
Jun 4, 2024 4 min read

PiggyBank is reader-supported. We may be compensated if you use, sign-up or apply for services through our links. See our Advertising Disclosure.

Subscribe to our daily newsletter to get the latest news, expert advice and exclusive offers!

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.

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.

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.

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.

Email Us

Is it better to pay the principal or interest?

It’s always preferable to pay your mortgage principal over the interest. The reason is that interest charges are calculated based on your remaining mortgage balance. Thus, the larger your principal, the more interest that will amass, especially over an extended period. Accelerating the pace at which you pay down the principal will reduce the interest you pay during your mortgage’s life.

What happens when you pay off principal on your mortgage?

Once you pay off your mortgage principal in full, your repayment obligations end and no further interest or fees accrue on your account. Your lender no longer has a legal claim on your home as you’ve met the terms and conditions of your contract. Still, you’ll have to take the necessary steps to discharge your mortgage (i.e., remove the lien from the property). This process involves your lender, lawyer, and provincial title registry office.

Is it better to make principal-only payments?

If your lender allows you to contribute principal-only payments toward your mortgage balance, you should take advantage of the privilege. Since principal-only payments are applied directly toward your outstanding principal, you’ll pay off your mortgage sooner and save on interest charges. However, ensure these extra payments don’t exceed the threshold outlined in your mortgage contract, or you could face a prepayment penalty.

Contributors

Mark Gregorski

Mark 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.