When you take out a mortgage, your payment may be comprised of several parts including the principal, interest, and mortgage insurance.
It’s important to understand each part of the payment so that you can choose the loan that is right for you. There’s no doubt that you will pay some type of fees, such as interest, as every lender charges interest as a fee to borrow the money.
Understanding the Principal
The principal balance of your loan is the exact amount of money you borrowed to buy the home. For example, if you borrowed $150,000, that is your loan’s principal. Any money you pay beyond that is likely interest or mortgage insurance.
When you buy a home, you agree to a purchase price for the home. Let’s say you agree to pay $200,000 for the home. You then agree to make a specific down payment. Let’s say you put down 10% or $20,000. That leaves $180,000 for the main portion of your loan or the principal balance.
What’s Added to the Principal?
Once you agree to a loan amount, the lender will charge you an interest fee. It’s shown as a percentage. For example, a lender may quote you a 4.5% interest rate. This means you pay 4.5% interest on the loan’s balance. At the start in our above example, you pay 4.5% interest on the $180,000 amount you borrowed. As you pay the loan balance down, the amount of interest you pay begins to decrease.
There’s one more thing that may be added to the principal depending on your loan program – mortgage insurance. You pay mortgage insurance if you borrow more than 80% of the home’s value and take out a conventional loan. You also pay it no matter the loan’s LTV on a FHA and USDA loan. The amount of insurance you pay depends on the loan program. If you take a government-backed loan, you pay the insurance for the life of the loan. If you take out a conventional loan, you pay the insurance until you owe less than 80% of the home’s value.
How the Principal Declines
Every month, as you make mortgage payments, you pay down the loan’s principal. When you first take out the loan, you will likely pay a smaller portion of the loan’s principal and a greater portion of interest. Each month as you pay the balance down, you pay less towards the interest and more towards the loan’s principal.
If you make the minimum payments as defined on your amortization table, you will pay the principal off in full as scheduled. If you pay extra money each month, though, you can knock the loan’s balance down faster, owning your home quicker than original scheduled.
As long as you have a principal balance, you will at least pay interest on the loan. The faster you pay the loan down, though, the less interest you will pay. If you can afford to make larger payments than you are required to make, you can save on the interest, decreasing the total cost of the loan.
