This Article Is About How Do Principal Payments Work On Home Mortgages
One of the most frequently asked questions by first-time homebuyers often ask How Do Principal Payments Work On Home Mortgages.
- The two basic components that make up a monthly mortgage payment are principal and interest
- Every month, when homeowners make their scheduled monthly mortgage payments, a portion of it goes to principal and the rest goes to interest
- The principal payment is what pays down the loan balance
- The most common home loan for homebuyers is the 30-year fixed-rate mortgage
- 15-year fixed-rate mortgages have lower interest rates but higher monthly payments
- When a new mortgage borrower starts making their monthly mortgage payments, it consists on P.I.T.I. ( principal, interest, tax, insurance)
- The first 15 years of the mortgage term, very little principal will be paid
- Most of the mortgage payments will go towards interest
Understanding How Do Principal Payments Work On Home Mortgages
Many borrowers think mortgages are complex.
- After they close, they want to put away the closing docs and not review the closing paperwork and documents
- A home purchase is most people’s largest investment in their lifetime
- Understanding how do principal payments work on home mortgages is important
- By understanding on how both principal and interest payments work can help you set goals in making extra payments towards principal
- Paying a little extra for principal every month can shave off years of a 30-year mortgage
- Paying extra towards principal does not have to be done every month
For example, if you make bi-weekly versus monthly mortgage payments on a 30-year fixed-rate loan, it will save you 7 years off the term of the loan. Therefore, you will have your mortgage paid off in 23 versus 30 years.
Understanding How Do Principal Payments Work On Home Mortgages: Principal Payment Explained
As mentioned earlier, there are two components to a monthly mortgage payment: Principal and Interest.
- The principal is the net amount of money you borrower from the mortgage company
- Your principal loan balance is the final purchase price minus the down payment
- If you purchased a home for $300,000 and put a 10% or $30,000 down payment, the principal home loan balance is $270,000
- You have $30,000 in equity and a principal mortgage loan balance of $270,000
- Your monthly mortgage payments are determined by the principal loan balance
- From the day you take out your loan and as time pass, the interest accumulates
- On top of the principal and interest, homeowners are responsible for property taxes and homeowners insurance
Most homeowners with escrow accounts pay the property taxes and homeowners insurance to their lender.
Understanding What The Interest Component Of Your Mortgage Payment Is
The principal payment of your mortgage goes to pay down the loan balance.
- Paying down the loan balance increases your equity
- The second component of your monthly mortgage payment is interest the lender earns for lending you the money
- The interest component of your mortgage payment is the cost you pay the lender for lending you the money for your mortgage
- The annual percentage rate, also referred to as the APR, is the actual cost borrowers pay for the home mortgage to the lender
- If a homebuyers gets a $200,000 home mortgage with an annual percentage rate (APR) of 4.0%, the total annual interest the borrower will pay will be $8,000
- There is no benefits to the borrower when they pay interest payments
Interest payments is the cost of having the loan and the money the lender earns for letting the homeowner keep a loan balance.
P.I.T.I. Explained
All government loans require escrow accounts.
- Borrowers who have more than 20% equity in their homes are allowed to waive escrow accounts
- However, escrow accounts are require on all conventional loans with loan to value greater than 80%
- Escrow accounts are set up by the mortgage servicer
- Part of the monthly housing payments include property taxes and homeowners insurance
- The mortgage servicer will collect the taxes and insurance along with the principal and interest
- When the bill for the property taxes and homeowners insurance is due, the mortgage servicer will pay them timely
- The principal and interest payments remain the same for the term of the loan
- However, the property taxes and/or homeowners insurance may increase and/or decrease
- Depending on the changes of the taxes and/or homeowners insurance, the housing payments may differ
- The mortgage servicer will adjust the escrow account accordingly
- Homeowners need to realize that they pay mostly interest when the loan term begins
- Only a small fraction of the mortgage payment will be applied towards principal
- As they pay further into the loan term, the amount that is applied towards principal increases
Once the 50% term mark is up, then more and more of the monthly mortgage payments will get applied towards principal.
Getting Ahead With Paying The Mortgage Loan Balance Earlier Than The End Of The Term
Every homeowners dream is to own a home without a mortgage. Many hard working homeowners set a goal and make it their mission to have their home mortgage paid off prior to the expiration of the term. You can do so by making extra payments towards your principal loan balance whenever you can. Just making one extra mortgage payment each year can cut 7 years of the life of a 30-year mortgage. Whenever you make extra housing payments towards your principal loan balance, make sure you note the principal payment on your statement and follow it up with a phone call to the mortgage servicer. Making extra payments towards paying down your principal can greatly reduce the term of your loan term and save you thousands in mortgage interest.
