There are two basic components that make up every mortgage payment: principal and interest. In this article, we’ll share everything you need to know about principal and interest in order to help you choose the best mortgage option for you. We’ll cover the differences between the two and help you determine what you owe, or will pay. Keep in mind, there may be other expenses that could find their way into your monthly payment as well.
What Is Your Principal Payment?
Your principal payment is the amount of money that goes directly toward paying down the amount you borrowed from your lender for your mortgage loan. It does not include interest or any other fees associated with the loan. Your principal balance is the total amount you owe on your loan, minus any payments you have already made. Every time you make a payment, your principal balance decreases.
What Is Your Interest Payment?
Your interest payment is what your lender charges you for the privilege of borrowing money from them. This fee is based on the amount of money you borrowed and the current interest rate they are charging. The higher the loan amount and/or interest rate, the more you will pay in interest. Most lenders also require you to pay a portion of the interest with each monthly payment. This is known as “pre-paying” your interest, or paying your loan in advance.
What Is Your Total Mortgage Payment?
Your total mortgage payment is the sum of your principal and interest payments, plus any other associated fees. Depending on the type of loan you have, this could include property taxes, homeowners insurance, private mortgage insurance (PMI), and any other fees that may be required by your lender. It’s important to understand your total payment in order to properly budget for it each month.
How Is Your Interest Rate Determined?
Your interest rate is determined by a variety of factors, including the type of loan you have taken out, your credit score, and the current economic climate. Your credit score is one of the most important factors in determining your interest rate; the higher your score, the lower the rate for which you can qualify. Additionally, lenders take into account your financial history when determining the interest rate for your loan. It’s important to understand that the interest rate you qualify for is not always set in stone—your lender may be willing to negotiate a lower rate if your credit score or other factors improve over time.
What Else Is Included In Your Monthly Payment?
Your monthly mortgage payment may also include some additional fees or charges. For example, if you are paying off your loan with a bi-weekly payment schedule, you may be charged an extra fee for the convenience of doing so.
Additionally, if you have an adjustable-rate mortgage (ARM), your monthly payment will typically include an escrow account , which is used to cover the cost of taxes and insurance. You may also have an additional line item for private mortgage insurance (PMI) if you are putting down less than 20% when purchasing your home.
It’s important to closely review your loan documents and understand exactly what fees you can expect in each monthly payment. This will help you budget accordingly and ensure that you are fully prepared for any unexpected expenses.
Will My Principal Or Interest Ever Change?
Under most mortgage agreements, you’ll pay the same amount in your mortgage payment each month until you pay off your loan. However, there are two instances where your monthly payment (or the number of years you have to pay your mortgage) may change: when you choose an adjustable-rate mortgage (ARM) and when you pay ahead on your loan.
Adjustable-Rate Mortgage (ARM)
An ARM is a type of mortgage where your interest rate changes with market rates. Usually, you’ll enjoy a few years of low fixed interest rates with an ARM. When that introductory period ends your rates will change based on market conditions. If market rates go up, your rate goes up. If market rates go down, your interest rate will too. This can affect your monthly mortgage payment because your interest rate can fluctuate. The initial introductory rate is lower than what you’d get with a standard fixed-rate mortgage, where your interest rate never changes for the life of your loan.
Paying Ahead On Your Loan
Your monthly mortgage payment can also change if you make an additional payment on your loan. This is because you only need to pay interest on the amount of money you owe. Most of your monthly payment goes toward interest at the beginning of your loan.
Over time the amount you pay each month chips away at your principal and the amount of interest you owe. This process, called mortgage amortization, gradually reduces your principal and what you owe in interest.
Paying just a little extra money each month on your principal can go a long way by helping you save a lot of money over your loan term. If this is something you are interested in and financially capable of doing, be sure to tell your lender that you want the extra payment to go towards the principal only.
Conclusion
When it comes to principal and interest, understanding the differences between them is key to making informed decisions when selecting a mortgage loan. Knowing the specifics of each component can help you choose a payment plan that works best for your budget, while helping you reach your financial goals. As always, speaking to your lender is the best way to ensure that you understand what you will be paying and how it affects the total cost of your loan.