Why does the majority of my mortgage payment start out as interest and gradually move toward mostly principal?

By Jared Coulson AAA
A:

When you make a mortgage payment, the amount paid is a combination of an interest charge and principal repayment. Over the life of the mortgage, the portions of interest to principal will change.

At first, your payment will be primarily interest, with a small amount of principal included. As the mortgage matures, the principal portion of the payment will increase and the interest portion will decrease. This is due to the interest charge being calculated off the present outstanding balance of the mortgage, which decreases as more principal is repaid. The smaller the mortgage principal, the less interest is charged. (If you have negative amortization and your mortgage is actually growing in debt, see Understanding the Mortgage Payment Structure.)

For example, let's examine a simple mortgage for $100,000 at an interest rate of 4% annually and a time to maturity of 24 years. The yearly mortgage payment is $6,558.68. The first payment will consist of an interest charge of $4,000 ($100,000 x 4%) and a principal repayment of $2558.68 ($6,558.68 - $4,000). The outstanding mortgage balance after this payment is $97,441.32 ($100,000 - $2,558.68). The next payment is equal to the first, $6558.68, but will now have a different proportion of interest to principal. The interest charge for the second payment equals $3,897.65 ($97,441.32 x 4%), while the principal prepayment is $2,661.03 ($6,558.68 - $3,897.65).

The principal portion of the second payment is about $100 larger than the first. This occurs because you've paid money towards the principal amount - lessening it - and the new interest payment is calculated on the lower principal amount. Near the end of the mortgage, the payments will be primarily principal repayments.

To learn how to start paying down your principal more quickly, see Be Mortgage-Free Faster.

RELATED FAQS

  1. What are the implications of a low Federal Funds Rate?

    Find out what a low federal funds rate means for the economy. Discover the effects of monetary policy and how it can impact ...
  2. Does the bank set up an escrow account for the buyer and seller in a home sale?

    Learn about the process of escrow and who is responsible for setting up escrow accounts for the buyer and seller in the purchase ...
  3. How does the bank profit off of escrow accounts?

    Discover the truth behind escrow accounts and the bank's profits. Are these accounts worthwhile or just another way for the ...
  4. Who manages an escrow account?

    Managing an escrow account is a job for a trusted and experienced service provider. Discover the best personal finance solutions ...
RELATED TERMS
  1. Total Annual Loan Cost (TALC)

    The projected total cost that a reverse mortgage holder should ...
  2. Forbearance

    A temporary postponement of mortgage payments.
  3. Mortgage Modification

    A permanent change in a homeowner's home loan terms that makes ...
  4. USDA Non-Streamlined Refinancing

    A mortgage-refinancing option offered by the United States Department ...
  5. No-Appraisal Mortgage

    A type of home loan used for refinancing for which the lender ...
  6. No-Appraisal Refinancing

    A type of mortgage for which the lender does not require an independent, ...

You May Also Like

Related Articles
  1. Stock Analysis

    Can American Capital Agency Maintain ...

  2. Stock Analysis

    How Two Harbors' Derivatives Work?

  3. Stock Analysis

    How Chimera Investment Bear The Brunt ...

  4. Stock Analysis

    How Are Interest Rates Affecting Annaly ...

  5. Investing

    Ready To Invest In Financial Leverage ...

Trading Center