What Is The Loan Principal In A Mortgage?

The principal is the amount you need to borrow to buy a home. When figuring out how much buying a home will cost you, it’s an essential number but not the only important factor. Read on to learn more about how to know how much principal you need to borrow, how it affects what a home will cost you, and how to repay it.

What Is The Loan Principal?

Your loan principal is the amount you borrow. As you make payments, your mortgage lender or servicer applies it to the interest you owe, with the remainder reducing your principal.

Keep in mind that the principal is not the total cost of the home, it’s the amount you borrow. For example, if you buy a $500,000 home, you might make a $50,000 down payment, pay $10,000 in closing costs, and get a $450,000 loan. The loan’s principal is $450,000 despite the $500,000 purchase price.

While there are different types of home loans, the way you repay a mortgage doesn’t generally change. You make monthly payments that reduce your principal. You own the house free and clear when you’ve repaid the entire principal. This typically happens over 15 or 30 years, though you can get loans with shorter or longer terms.

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How Is A Mortgage Repaid?

As with most loans, you repay your mortgage over time by making a monthly payment. The key things to know about the loan are its interest rate and term.

Interest Rate

The interest rate of your mortgage determines how much you’re paying the lender to borrow the principal. Interest is expressed as a percentage of the loan amount and is added to the loan’s value each year. For a simplified example, imagine you had a $10,000 loan at 5% interest and made no payments for a year. After one year, the loan’s balance would be $10,500, 5% higher.

Fixed Vs. Adjustable Rates

Mortgages can have fixed or adjustable interest rates.

Fixed rates do not change. That predictability means you won’t have to worry about changes in the market interest rate increasing your monthly payment.

Adjustable-rate mortgages usually start out with lower rates than fixed-rate loans. After an initial period, your interest rate will change based on market rates. If those rates increase, so will your monthly payment.

Loan Term

The loan term refers to the repayment schedule and how long it will take to repay the principal with interest, assuming you follow the minimum payment schedule. Mortgages usually have terms of 15 or 30 years.

Amortization

Amortization calculates a monthly payment that repays the principal with interest over a specific period. This splits your payment into interest and principal. At first, most of your payment goes toward interest. But as each payment reduces the principal, there’s less interest to pay, and more of your payment goes toward reducing the principal. By the end of the repayment schedule, most of the payment will be toward the principal and a small portion toward interest.

For example, if you get a $500,000 mortgage at 6% interest, your monthly payment will be $2,998. Of your first payment, just $498 will go toward reducing the principal, with the remaining $2,500 paying off accrued interest. With your final payment, only $15 will go toward interest, with the remainder paying off the last of the principal.

Home Equity

Equity is the difference between what your home is worth and how much you owe on it. As you pay down the principal, you build equity. You also can build equity as the value of your home increases in relation to how much you owe. It’s expressed as a percentage of your home’s value and can be understood as how much of your home you own.

For example, say you buy a home for $400,000, make a down payment of 10%, and borrow $360,000 with a 30-year fixed-rate mortgage at 6.5% interest. After five years, you will have paid down your mortgage principal to $337,000. If your home is still worth $400,000, you will have $63,000 in equity, which is about 16%. If your home increases in value to $420,000, you’d have $83,000 in equity, which is about 20% equity.

The advantage of having equity is you can borrow it to pay for significant expenses using a home equity loan, line of credit or a cash-out refinance. If you sell the home, your equity would be your profit after paying off your mortgage balance with the proceeds.

You can figure out your home equity with our mortgage amortization calculator.

What Is Included In My Monthly Mortgage Payment?

Your monthly mortgage payment can include several different costs. Keep in mind that not all loans are the same, so you may not see all of these charges included in your loan, either because you pay for them separately or you don’t need to pay them at all.

Principal And Interest

Principal and interest are included in every mortgage. They are the primary and likely most significant component of your monthly payment, covering all of the interest accrued that month plus enough principal to ensure that you stay on schedule to pay off your loan.

If you have a fixed-rate loan, this portion of the loan payment will not change. If you have an ARM, rate adjustments could cause this portion of the payment to rise or fall.

Property Taxes

Most mortgage lenders require borrowers to make monthly payments toward their property taxes as part of their mortgage payment. Your lender holds this money in an escrow account and pays the bill on your behalf when it’s due. Some lenders may let you skip escrow for property taxes. If you do, you’re responsible for paying the taxes yourself.

Homeowners Insurance

Almost every lender requires homeowners insurance to protect the home from damage or destruction. Depending on the lender, you may have to let the lender handle your insurance payments and make monthly payments into an escrow account along with your mortgage payment, or you may be able to pay for the insurance yourself.

HOA Fees

If you live in a homeowners association, you must pay HOA fees and dues. Many lenders require that you pay these fees along with your mortgage payment.

Are My Loan Principal Payments Tax-Deductible?

Repayment of your mortgage principal is not tax-deductible, but your interest payments might be. Thanks to some homeowner tax incentives, you can often deduct some or all of your total yearly mortgage interest payments from your taxes.

For Individuals

If you have a loan to buy, build or improve a primary or second home, you likely can deduct the interest you pay on it. For mortgage loans issued since Dec. 16, 2017, homeowners can deduct up to $750,000 in paid interest. Mortgages issued before that date can deduct up to $1 million.

For Businesses

If you have a mortgage loan for a home that you use for business purposes, the rules for deducting interest are a little different, but there are still some benefits you can claim. For example, if you own a home you use as a rental property, you likely can claim depreciation on your taxes. Rental property depreciation allows you to claim depreciation on your property, granted it has a verifiable usable life, meaning it breaks down in quality or value over time.

If you use the property for a business that isn’t a rental property, you may be able to claim your mortgage interest as a business expense. You just need to make sure that it’s a business you operate yourself so that the interest can be claimed when itemizing profits and losses.

How Can I Repay My Mortgage Principal Faster?

You typically pay down your principal slowly, as amortization means you pay interest first and then reduce the principal. But what if you want to repay your principal faster? Repaying your loan more quickly can help you build equity and shorten your loan term, allowing you to save on interest over the life of the loan.

So, how can you do it? Let’s talk about a few ways you can work toward paying off your mortgage early.

Biweekly Payments

No matter the size of your loan, your monthly mortgage payment is likely a little overwhelming. One solution to make this payment more manageable and pay down your balance more quickly is to make biweekly mortgage payments.

If you typically pay $1,500 per month, switching to a biweekly schedule would mean paying $750 every two weeks instead. Splitting up the payments can make each payment more manageable and allow you to pay more each year.

A monthly schedule requires 12 payments a year. But with 52 weeks in a year, a biweekly schedule requires 26 half payments – equal to 13 monthly payments. That may not seem like a big difference, but it can allow you to pay off your loan years ahead of schedule and save a lot of money on interest.

Mortgage Recast 

The larger the down payment, the less you must borrow to buy a home upfront. A smaller principal reduces the monthly mortgage payment and saves you money on interest. But what if you could do the same thing later in your loan term?

You can do just that with a mortgage recast, also called mortgage re-amortization. You pay a lump sum toward your balance, and your lender recalculates the amortization of your new loan balance over the remainder of your term. This can reduce your monthly payment significantly.

Not all loans or lenders allow recasting. Federal Housing Administration, Veterans Affairs, U.S. Department of Agriculture, and most jumbo loans are ineligible for recasting. Lenders also will have their own requirements about how much you can contribute and when.

Make Extra Payments

Your monthly payment is a minimum. If you pay more than the minimum, you can apply the extra amount to the principal. This reduces your principal more quickly and allows you to pay off your mortgage more quickly while also saving you money on interest. For example, some homeowners pay one and a half times their monthly payment, with the extra applied to the principal.

For example, let’s say you take out a 30-year fixed-rate loan for $360,000 at 7% interest to buy a house. Making the monthly payment of $2,158 for 30 years means you’ll pay $417,007 in total interest. If you paid an extra $300 a month, you would pay off your loan after 22 years and one month while paying a total of $289,388 in interest. This would save you $127,619 in interest and almost eight years of mortgage payments.

Refinance Your 30-Year Term Into A 15-Year Mortgage

For those truly dedicated to achieving financial independence and paying off their loan as soon as possible, refinancing to a shorter term is another option.

If you refinance a 30-year loan to a 15-year loan, you can pay off the principal balance in half the time, but your monthly payment will be significantly higher. If you can afford it, this is a great way to pay off your home ahead of time and get the stress of monthly mortgage payments out of the way for good.

While you’ll save a lot of money on interest, you’ll have to pay closing costs to refinance. Expect closing costs to equal 2% to 5% of your new loan amount.

FAQ

Here are answers to common questions about mortgage principal.

The Bottom Line

Your loan principal is the total amount that you originally borrowed to purchase your home – and to own your home free and clear, you must pay it off plus interest. This can be a very costly and time-consuming endeavor. Luckily, there are plenty of ways to pay down your principal faster if you have the means to do so.

T.J. Porter contributed to the reporting of this article.

T.J. Porter

T.J. Porter is a Boston-based writer who focuses on credit cards, credit and bank accounts. When he's not writing about all things personal finance, he enjoys cooking, esports, soccer, hockey, and games of the video and board varieties.

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