Mortgage principal definition and basics

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When you take out a mortgage, the amount you're borrowing is called the principal. Repaying the principal is just one part of your monthly mortgage payment, which plays a significant role in deciding how much house you can afford. Learn more about the factors at play in borrowing and repaying your mortgage principal.

What is the principal of a loan?

A loan principal is the amount you borrow when you get a mortgage. This is the amount you will repay your lender, plus interest. Your principal is a significant factor in determining your mortgage payment, which varies based on your mortgage interest rate, loan term, and whether you use an escrow account to pay property taxes and homeowners insurance. 

Your initial principal can be calculated by subtracting any down payment from your home’s purchase price. For example, if you buy a $350,000 property with a $50,000 down payment, your initial principal would be $300,000.

Initial vs. outstanding principal

Principal also can refer to the outstanding balance on your mortgage. The initial principal is the original amount you borrow, while the outstanding principal is the amount you owe now after having made payments toward the initial principal.

For example, if you get a mortgage for $350,000, your initial principal also is $350,000. After 5 years of payments, you've paid $20,000 toward your principal, leaving an outstanding principal of $330,000.

What is your principal payment?

Your principal payment is the portion of your monthly mortgage payment that reduces your loan balance. The remainder is interest and also may include escrow payments to cover homeowners insurance and property taxes. Together, this is known as PITI, for principal, interest, taxes, and insurance.

Amortization schedule and your principal payment

Amortization is a method for calculating interest and principal payments to pay off a loan over a specific number of payments.

If you choose a 30-year fixed mortgage, your loan will be amortized over 360 monthly payments, and the loan balance will be zero after the final payment.

Amortization also calculates a monthly payment that covers all the interest that accumulated on your loan since the last payment, with the remainder reducing the principal.

This means that when you start paying your mortgage, most of your payment will go to interest. With each payment, less will go toward interest and more toward the principal. Toward the end of your loan term, most of your payment will go to principal.

Lenders will create an amortization schedule that shows how each payment is allocated between interest and principal.

You can use the amortization calculator from Rocket Mortgage to see a breakdown of your loan payment for a fixed-rate mortgage.

What is mortgage interest?

Mortgage interest is an amount you pay your lender in addition to the loan balance. Interest is how the lender makes money from lending you the principal.

Interest is the lender's compensation for providing the loan. It is expressed as a percentage, with a lower mortgage rate costing less than a higher one. Today's Rocket Mortgage rates are available online.

Mortgage rates are determined by overall economic conditions, including the federal funds rate and Treasury rates. Your rate also is affected by your credit history, credit score, debt-to-income ratio (DTI), savings, and how much you're borrowing.

Your lender also will provide you with an annual percentage rate (APR), which includes the interest rate and costs such as origination or application fees you need to pay to get the loan. APR is an effective way to compare Loan Estimates from different lenders. A loan may have a lower interest rate than another, but if it charges more fees, the APR may show that the higher-interest loan is less expensive.

Mortgage principal and interest rates

The interest rate on your mortgage depends on many factors, including:

• Current economic conditions
• Your credit score
• Your income
• Your down payment amount

Even a slight difference in interest rate can have a significant impact on your monthly payment.

For example, a 30-year fixed-rate mortgage on a $350,000 home with a 5% down payment and a 6.375% interest rate would have a monthly payment of about $2,074, excluding property taxes, homeowners insurance, and private mortgage insurance (PMI). You'd pay a total of $414,272 in interest for that loan.

Meanwhile, the same mortgage with a 5.625% interest rate would have a payment of $1,914, and total interest payments of $356,561. That saves you $160 a month and $57,711 in total interest.

What else is included in your monthly payment?

While interest and principal make up the bulk of your monthly mortgage payment, there may be additional charges included.

For example, many lenders offer an escrow account for homeowners to pay their homeowners' insurance and property taxes. The lender estimates the annual cost of these expenses and adds a prorated monthly amount to your principal and interest payment. The lender holds this money in an escrow account and pays your tax and insurance bills on your behalf.

Escrow accounts ensure that taxes and insurance bills are paid on time, preventing default on these significant expenses.

Property taxes

Property taxes can be a significant cost of homeownership and are an important source of funding for your local area, such as public schools, fire departments, and road repairs.

The amount you pay in property taxes may go up each year. Your local tax collector should provide information to you each year about what your proposed amount will be.

Homeowners insurance

Homeowners insurance protects your home against covered disasters like theft, fire, and certain types of natural disasters. Like property taxes, factors such as your home's location and value play a big role in how much you pay. How many claims you made in the past, and any additional features of the house – like a pool – could also affect your insurance premiums.

While costs vary, the national average annual homeowners insurance premium is between $900 and $1,800.

Mortgage insurance

You may need to pay mortgage insurance, depending on the type of loan you have and the size of your down payment. Mortgage insurance helps cover the lender's losses if you default on your mortgage.

With a conventional loan, you'll have to pay for private mortgage insurance (PMI) if you put down less than 20%. You pay for PMI until you have at least 20% equity.

If you buy a home with an FHA loan, you must pay mortgage insurance premiums (MIP). There's an up-front MIP paid at closing, and an annual MIP based on your mortgage balance, divided into monthly payments. If you put down at least 10%, you pay the annual MIP for 11 years. If you put down less, you pay the annual MIP for the entire loan term.

U.S. Department of Agriculture loans have a similar fee, called a guarantee fee. USDA borrowers pay an up-front and an annual guarantee fee. Rocket Mortgage currently doesn't offer USDA loans.

Homeowners association fees

If your home is part of a homeowners association, you must pay HOA fees. An HOA manages and pays for common expenses for its members, such as open spaces, pools and recreation facilities, clubhouses, security services, parking, and landscaping. If you live in a condo, there may be an HOA or condo association that maintains the building's exterior and other common amenities.

Will my principal and interest payment change?

If you take out a fixed-rate mortgage, your total principal and interest payment will not change. If you pay property taxes or homeowners insurance through an escrow account, those costs may change, and your total monthly payment may adjust accordingly.

Your principal and interest rate may change depending on your loan type and whether you make extra payments.

Adjustable-rate mortgage

If you choose an adjustable-rate mortgage (ARM), you typically have a fixed interest rate for a specific time. After that, your interest rate will change at specific intervals, depending on overall economic conditions.

Paying ahead on your mortgage

Paying more than the required payment allows you to apply the extra amount to your principal. This reduces your balance, helping you pay off your mortgage ahead of schedule while saving money on interest.

For example, putting an extra $100 toward your monthly payment on a 30-year loan would amount to paying off an extra $1,200 per year, which could shorten your loan term by years.

Keep in mind that if you want to allocate additional amounts to your principal, you should contact your lender to ensure the extra payment is allocated to your principal.

The bottom line: Keep track of loan principal and interest

By tracking your mortgage interest and principal payments, you can better budget for your monthly payment and monitor your loan paydown. In some cases, this information may motivate you to pay off your mortgage faster by making additional payments.

If you’re looking for a new home, start the mortgage process early by applying for a loan from Rocket Mortgage today.

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