What Are Mortgage Principal and Interest?

When you have a home loan, you’re supposed to make the monthly payment specified in the loan contract. When you make that payment, you’re essentially making a payment that gets divided between the two basic components of the loan: principal and interest.

What Is Mortgage Principal?

Your mortgage’s principal is the initial amount of money that you borrow when you take out a home loan. In order to figure out the principal, just subtract what you paid for a down payment from the selling price of the home. Let’s say that you bought a home for $250,000 and you put down $40,000 as a down payment. The remaining number, $210,000, is the principal.

This number should be one of the most important numbers you take into consideration when deciding if you can afford a home. The principal amount that you borrow from the lender is the amount upon which interest accrues as soon as you take out the loan. The additional costs that start to build on top of these two numbers include, but are not limited to, property taxes, the cost of maintenance and repairs, homeowners insurance, additional insurances, and more. If you’re not sure how much you can really afford, there are mortgage calculators available online.

What Is an Interest Payment?

This is the second part of a mortgage loan after the principal amount. Interest is the money you agree to pay to your lender because they gave you a home loan. Many lenders will calculate interest in the annual percentage rate (APR) method. APR is the amount you will be paying on the loan per year.

Although the numbers may not seem that big, when you calculate their relation to the principal cost of the mortgage, even just a few percentage points can make a massive difference over the course of a 15- to 30-year mortgage loan term. For example, someone borrowing $150,000 at 4.00% with a loan term of 30 years would have a monthly payment of $716.12. If the same loan had a 6.00% rate of interest, the monthly payment would increase to $899.33. After 30 years, the difference equates to an excess of more than $67,000 in interest alone.

The interest rate that you’re able to work out with the lender is dependent on many factors, including your income, credit score, and debt-to-income ratio, plus the amount that you put down on the property.

If you take into consideration the vast difference in interest costs, even from a “mere” 2%, then it makes sense to tend to your credit score and see if you can raise it before even starting the mortgage loan application process.

Are Mortgage Principal and Interest the Only Parts of My Monthly Payment?

The answer to this question depends on your mortgage lender, but for the most part, principal and interest make up the majority of the mortgage payment. In some cases, the two will be the only parts of the payment, but in other cases, there are additional things included. The payment may cover the costs and fees, such as insurance, taxes, and escrow. Let’s break it down a bit to see what may be included in the payment.

Insurance

There isn’t a legal requirement that makes home insurance compulsory, but many lenders will not even give you a loan until you prove that you have adequate homeowners insurance. This type of insurance will cover many home-related issues that might arise, including covering damage from fires, lightning storms, and break-ins.

There are additional insurance policies that can cover your home and property against natural hazards, such as earthquakes and flooding. The cost for homeowners insurance will be dependent on a handful of factors, such as the home’s value, where it’s located in relation to a fire station or police department, whether it’s located in an urban or rural area, and the neighborhood where it’s located.

Taxes

Property taxes will need to be paid regardless of where you live. They go to the local government in order to pay for public services such as infrastructure projects, public schools, emergency services, and libraries, among other things. Although they are the more overlooked part of buying a new home, they absolutely need to be investigated, as they can be one of the most expensive components.

Part of the reason that you have to get the home appraised during the loan application process is so your taxes can be correctly determined by the local government. Again, the value and location of the home will play into the annual amount due, as will what sort of community amenities the locale offers. The rate can change each year, and some counties can require that homeowners get a new appraisal every two years.

Escrow

An escrow account is used by mortgage lenders who want to take a certain percentage of the payment and set it aside in the account to ensure that property taxes (and sometimes insurances) are paid in full and on time.

Is It Possible to Change the Principal or Interest?

With most mortgage contracts, you will pay the same amount each month until your loan is paid in full. The only two ways either could change is if you get an adjustable rate mortgage (ARM) whose interest rate changes with the market’s ups and downs. Secondarily, it is possible to “get ahead” on your principal when you pay ahead, and if your agreement has no early payment penalties, you should be able to save on interest paid over time by cutting down on the repayment duration and the amount upon which the interest calculation is based.

If you’re looking to refinance in order to lower your interest rate, speak with one of Rivermark’s mortgage experts.